What is DSCR? Definition, formula and example
This is for anyone planning to buy a business with a loan, and for sellers who want to know how much debt their business can carry. By the end you will know how the debt service coverage ratio (DSCR) is worked out, what lenders want to see, and how it caps the price you can pay.
What DSCR means in plain words
DSCR answers one question a lender asks before anything else: after the business pays its bills and its new owner, is there enough left to pay the loan, with room to spare? A ratio of 1.0x means the cash flow equals the payments exactly. Anything below 1.0x means the owner must put in money from elsewhere. Above 1.0x is the cushion.
Lenders think in cushions because sales dip, trucks break and customers leave. The bigger the ratio, the more can go wrong before a payment is missed.
The DSCR formula
DSCR = cash flow available for debt service ÷ annual debt service
Cash flow available for debt service usually starts from adjusted EBITDA or SDE. From that, the lender subtracts a market salary for the owner-operator, income taxes, and often a reserve for equipment replacement. What remains is the cash that can go to the bank.
Annual debt service is the total of principal and interest due in a year on every loan the business will carry after closing: the bank loan, any seller note, and existing equipment loans that stay. Investopedia's DSCR page sets out the same formula.
A worked example
Illustrative example: a $1.5M-revenue landscaping company bought for $1,000,000 with an SBA 7(a) loan.
| Line | Amount | Note |
|---|---|---|
| SDE | $320,000 | Rebuilt from three years of tax returns |
| Less: owner-operator salary | −$90,000 | Market wage for the buyer's role |
| Less: replacement equipment reserve | −$30,000 | Mowers and trucks wear out |
| Cash flow available for debt service | $200,000 | |
| SBA 7(a) loan: $800,000 over 10 years at 10.5% | $129,500 | Annual principal + interest |
| Seller note: $100,000 over 5 years at 7% | $23,800 | Annual principal + interest |
| Annual debt service | $153,300 | |
| DSCR | 1.30x | $200,000 ÷ $153,300 |
At 1.30x this deal would clear the bar most lenders set. If the buyer had offered $1,200,000 with a $1,000,000 bank loan, annual debt service would rise to about $185,700 and the DSCR would fall to about 1.08x. The same business, a higher price, and the loan is probably declined.
Where DSCR shows up in a deal
The bank runs it first. For an acquisition loan, lenders commonly want a DSCR of about 1.25x or more, and the SBA's lending rules, SOP 50 10, set a floor the lender may not go below on 7(a) loans. Lenders also look at the buyer's global DSCR, which adds the buyer's personal income and personal debts to the picture.
Buyers should run it before they offer. If the DSCR at your price is under 1.25x, the fix is a lower price, a larger seller note with payments that start later, or more equity in. That arithmetic is a normal part of buying a business. An acquisition sponsor uses the same test on every deal in a group, because one weak business can pull the whole group's coverage down.
Common mistakes
- Using SDE without taking out a salary. The buyer has to eat. Lenders subtract a market wage first.
- Forgetting the seller note. Its payments are debt service too, unless the note is on full standby.
- Ignoring equipment replacement. A fleet that is five years old will cost money inside the loan term.
- One year of cash flow. Lenders average or weight several years; a single strong year does not carry a loan.
- Testing the business only. The buyer's own mortgage and car payments count in the global ratio.
Questions people ask
What DSCR do SBA lenders want?
Most SBA 7(a) lenders look for about 1.25x or more on an acquisition. The SBA's SOP 50 10 sets a minimum the lender cannot go below, and many lenders set their own bar above it.
What happens if the DSCR is below 1.0x?
The business does not earn enough to pay its loan. The buyer would have to cover the gap personally, so a lender will usually decline or ask for a lower price, more equity or a seller note with deferred payments.
Does the seller note count in debt service?
Yes, unless the lender agrees that the note is on standby, with no payments for a set period. Any seller note that is being paid is part of annual debt service.
How is global DSCR different?
Global DSCR adds the buyer's personal income and personal debt payments to the business figures. A buyer with large personal debts can fail the global test even when the business alone passes.
Sources
- sba.gov — https://www.sba.gov/funding-programs/loans/7a-loans
- sba.gov — https://www.sba.gov/document/sop-50-10-lender-development-company-loan-programs
- investopedia.com — https://www.investopedia.com/terms/d/dscr.asp
Pober, M. (2026). What is DSCR? Definition, formula and example. Acquisitions.com. https://acquisitions.com/blog/what-is-dscr/
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