Debt service coverage ratio (DSCR)
Debt service coverage ratio compares a business’s available cash flow to the loan payments it must make over the same period. A DSCR of 1.0 means the business generates exactly enough to cover its debt and nothing more; lenders want a cushion above that.
DSCR is the single calculation that most often determines the size of an acquisition loan. A buyer can be creditworthy, experienced and well capitalised, and still be told the loan must shrink — because the business itself does not throw off enough cash to service the debt with room to spare.
Why the cushion exists
A ratio of exactly 1.0 leaves nothing for a slow quarter, a lost customer, an equipment failure or an interest-rate move. Lenders therefore underwrite to a comfortable margin above 1.0, and they apply it to adjusted cash flow after the buyer’s own compensation — not to SDE, which assumes the owner takes nothing.
What this means for a buyer
DSCR is why purchase price and loan size are not the same conversation. If the ratio will not support the debt, the gap has to close somewhere else: a larger down payment, a vendor take-back that defers part of the price, or a lower price. Modelling it before making an offer avoids discovering the ceiling after an LOI is signed.
Sources
This definition is checked against primary sources. Links were last confirmed on the dates shown.
- 01Innovation, Science and Economic Development CanadaGovernmentCanada Small Business Financing Program
- 02Business Development Bank of CanadaIndustryHow to sell your business
- 03Treadstone LawLegal commentaryLoan Covenants in Ontario Business Acquisition Financing
- 04Treadstone LawLegal commentaryFinancing Options for First-Time Business Buyers in Ontario
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