Debt service coverage ratio, or DSCR, measures whether a business generates enough cash flow to cover its loan payments. It is calculated by dividing annual cash flow by annual debt service. A DSCR of 1.25 means the firm produces 25 percent more cash than its payments require, and that is the floor most SBA lenders want to see on an acquisition loan.
How banks calculate it for an A/E firm
Lenders work from three years of tax returns and use historical cash flow, EBITDA or Seller's Discretionary Earnings with documented add-backs, never projections. They then divide that proven cash flow by the annual payments on the proposed acquisition loan. If the ratio clears their threshold with room to spare, the deal finances. If it does not, the price or structure has to change.
A worked example
Take an engineering firm generating $700,000 in annual cash flow, purchased with a $2,500,000 SBA loan on a 10-year term at Prime plus 2.75 percent. With Prime at 7.5 percent, the rate is 10.25 percent and annual debt service runs about $400,000. That is a DSCR of roughly 1.75, comfortably above the 1.25 floor, which is exactly the kind of cushion that gets a loan committee to yes.
Why DSCR sets the ceiling on your deal
DSCR is the single number that converts a firm's cash flow into a maximum supportable loan, which in turn caps the price a bank-financed buyer can pay. A firm valued at a healthy EBITDA multiple still has to clear coverage on the resulting debt. When coverage is tight, deals get restructured with a larger seller note or a lower price. Owners planning an exit two or three years out can move this number directly by growing profitability and documenting add-backs cleanly.
