In this video, Carl Allen introduces and explains the Debt Service Coverage Ratio (DSCR), a key metric that lenders assess when considering business financing. He encourages viewers to appreciate the importance of numbers before delving into DSCR, which represents the business’s cash flow divided by its debt obligations. Carl explains that a DSCR of 1.5 or higher is generally desirable, though some lenders might accept a minimum of 1.3. Using a sample business model, he demonstrates how to calculate DSCR, basing it on EBITDA divided by annual loan payments.

He walks through a scenario with a $2 million revenue business at a 15% profit margin, yielding a $300,000 EBITDA. With a purchase price of $900,000 at a 3x multiple, and using an SBA 7(a) loan, Carl details financing structures, including down payments and seller notes. Assuming an 8% interest rate over ten years, the annual debt service would be approximately $105,000.

By dividing the $300,000 EBITDA by the debt service, Carl calculates a DSCR of around 2.9, comfortably above the target. He emphasizes that maintaining a DSCR above 1.5 ensures favorable loan terms and confidence from lenders, particularly the SBA. Additionally, if the DSCR were lower, adjustments to the purchase price would be necessary.

Carl stresses that achieving a strong DSCR simplifies the buying process, as lenders are more likely to approve the deal, provided it aligns with the buyer’s strategy. Finally, he encourages viewers to engage by subscribing and asking questions, highlighting his commitment to sharing helpful content.

Full Transcript:

Hey, guys. Carl Allen back with another video for you today. Again, we’re gonna be back looking at some numbers. So before we start, I want you to repeat after me.

I love numbers and numbers love me. Come on, guys. Louder. I love numbers. That’s better.

Numbers love me, as if the Internet can speak back. But, anyway, there we go. So I’m gonna be talking to you today about something called DSCR. Now you’re probably thinking, you know, WTF, what is what the hell is d f is DSCR.

Right? So DSCR stands for debt service cover ratio. On one of my earlier videos, I spoke to you about what are the key numbers that an investor wants to look for when they’re investing in your deal. If you’re a bank or if you’re somebody inside of the SBA program or if it’s a hard money lender or any sort of debt financing, there’s one killer number that they want to see in your model, and it stands for debt service cover ratio.

So let’s give you an example of what debt service cover ratio is. But it’s basically how much cash flow does the business generate divided by how much cash needs to go out to service the deal. Right? So we use EBITDA as our measure, and we divide it by debt service.

So that the EBITDA of the business is pumping out divided by the debt service equals debt service cover ratio, and you want it to be greater or equal to one point five zero. Some banks in the SBA program will let you get away with about one point three. That’s a little bit tight. You want a little bit of extra headroom.

You want life to be easy. Right? So one point five debt service cover ratio, you are golden. So let’s do an example.

So let’s say we’ve got a business and the revenues are two million dollars. Let’s say fifteen percent profit margin, which will be three hundred thousand dollars in profit, and that’s our EBITDA. Right? So that’s our profitability that the business is generating.

And then let’s say we’re gonna buy that business at a three times multiple. So we’re gonna pay three x for that business. So it’s nine hundred thousand dollars. And let’s say, like a lot of people, you wanna go and do that via an SBA seven a loan.

So typically with SBA seven a loans, you’re putting ten percent down at the closing table, which should be ninety thousand dollars. I have a video on this channel to show how to go and get that and how to forecast the returns. It doesn’t have to be your money. You can go and get somebody else to do it.

Eighty percent would be the SBA loan, which would be seven hundred and twenty thousand dollars, and then you’d have ten percent, seller note, which will be a standby seller note. Typically, the seller doesn’t get that money until the loan the SBA loan has been paid back. So seven hundred and twenty thousand dollars, let’s say that’s at ten years, which is the seven a loan program, and it’s at, say, eight percent. That would be, if my mental math serves me right, about a hundred and five thousand dollars per year.

Right? So we’re buying a business that’s cranking out three hundred thousand dollars in EBITDA. We cast it or adjust it, and it’s gonna cost us a hundred and five thousand dollars a year to service that loan. So the debt service cover ratio is easy.

Right? It’s the three hundred thousand, which is our current EBITDA, divided by our debt service, which is a hundred and five thousand a year.

And that number is just less than three. It’s about two point nine x or so if my mental math is working. So that’s debt service cover ratio. We’re way north of one point five. The SBA are gonna do that deal all day long providing that deal is in your lane, and there’s no, flies on that deal when they do due diligence.

If if the business was doing two hundred thousand dollars a year of debt service cover ratio, it would still work, but, obviously, your purchase price would be less. So stick to one point five or more, and you would be absolutely golden. And that, my friends, is the debt service cover ratio explained. Don’t forget to hit like and subscribe so you can get access to all of my other videos in real time.

And if there’s a question that, is burning for you and I’ve not answered it yet on one of these multiple videos, just type into chat what the question is, and I will do that personal video for you. I know it’s gonna help you, and it’s probably gonna help tens of thousands of other people as well. So I hope you enjoyed that, and I will see you soon for the next video. Until then, bye for now.