Combined Debt Coverage and Why it Matters to Banks
At SmartBiz Loans, we’re sharing important information you need to know to get SBA loan ready. No longer a mystery, we have identified 7 key metrics lenders consider before granting a small business an SBA loan.
We’ll unpack all 7 of these key bank criteria for you in simple and easy terms in a series of articles so you’ll know how changes in your business will affect your SBA loan readiness.
Here, we’re going to explore one of the more important metrics called “Combined Debt Coverage.”
Combined Debt Coverage: What is it?
Combined Debt Coverage is calculated by dividing total annual business and personal cash flow by the total annual business and personal debts. This ratio adds together your annual personal and business cash flow and compares them against your combined annual personal and business debts.
Why This Ratio Matters
Your Combined Debt Coverage is important because it helps banks assess whether there is enough personal and business cash flow to cover the payments for all personal and business debts. It indicates that the business owner does not have to dip into savings or take out another loan to make loan payments.
What Should Your Goal Be?
> 1.25 = Acceptable Borrower
- When it comes to Combined Debt Coverage, banks prefer to see a ratio of at least 1.25 or greater. This ratio indicates to lenders that you’re able to cover payments for all personal and business debt.
< 1 = Not Enough Cash Flow
- A ratio of less than 1 indicates your business doesn’t have enough cash flow and suggests it is unlikely you could repay a loan. This means that the business owner would have to use personal or business savings or obtain another loan to keep debt payments current.
** Important – banks can use slightly different approaches when calculating Combined Debt Coverage in terms of expenses included in how they define cash flow or debt.
Factors that can Improve Your Score
There are two solid ways a small business owner can improve this important ratio:
1) Increasing personal and/or business cash flow.
For in-depth information about increasing cash flow, visit this SmartBiz blog post here.
2) Decreasing debt.
The SmartBiz blog has an article outlining strategies to decrease debt here.
Not sure if you qualify for an SBA loan? Try the new SmartBiz Advisor™ online, educational tool to learn about how you can get your business SBA or bank loan ready – no cost involved. You can assess key criteria banks consider and where your business stands on each. Learn more about SmartBiz Advisor here.