Applying for an SBA Loan? Know Your Combined Debt Coverage
Many entrepreneurs applying for an SBA loan don’t know how banks evaluate the financial health of their business. SmartBiz Loans set out to solve that problem and we’re empowering business owners through a new (and free!) online tool, SmartBiz Advisor.
Created specifically for small business owner, SmartBiz Advisor acts as an Intelligent CFO™ for your business. Just like a CFO in a large business, SmartBiz Advisor can help you learn how to build your business lending profile by educating you about 7 key financial areas banks review when making lending decisions. After all, SmartBiz Loans knows that your business is more than just a credit score.
One of the important financial ratios that banks review before granting an SBA loan is your Combined Debt Coverage. Read on to learn more about this important ratio and how you can improve your scores if needed.
How to Calculate Combined Debt Coverage**
Combined Debt Coverage is calculated by dividing total annual business and personal cash flow by the total annual business and personal debts. Here’s what you need to know about these measurements of business and personal financial health.
Business Cash Flow
How you manage business cash flow can be the difference between a business with staying power and one that tanks.
According to Investopedia, cash flow is the net amount of cash and cash-equivalents moving into and out of a business. Positive cash flow indicates that a company’s liquid assets are increasing, enabling it to settle debts, reinvest in its business, return money to shareholders, pay expenses and provide a buffer against future financial challenges. Negative cash flow indicates that a company’s liquid assets are decreasing.
Here’s a comprehensive article from NerdWallet that gives you step-by-step instructions to calculate your businesses cash flow: How to Calculate Business Cash Flow
Personal Cash Flow
In short, a positive net cash flow means that you earned more than you spent and that you have some money leftover from that period. On the other hand, a negative net cash flow shows that you spent more money than you brought in. Here’s a guide to help you calculate your personal cash flow: How to Create a Personal Cash Flow Statement
Business debt, also referred to as commercial debt, is debt owed by a business and can be good or bad. Good debt has low rates, long terms and manageable payments. Bad debt, like credit cards or lines of credit, can have high rates, short terms and payments that cut into cash flow. The SmartBiz Small Business Blog has an article for business owners who need to lower debt: How to Reduce Bad Business Debt.
Personal debt is debt owed for which you personally are legally responsible. Credit cards, student loans, mortgages and car loans are all types of personal debt. Like business debt, personal debt can be good.
What Should Your Combined Debt Coverage Goal Be?
If your goal is to acquire a low-cost SBA loan, pay attention to the ratios below.
> 1.25 = Acceptable Borrower
- 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.
Why Combined Debt Coverage 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.
How to Improve Your Score
The good news is that you can improve your Combined Debt Coverage ratio with two solid strategies. The first is to increase personal and/or business cash flow. The second is by decreasing debt. Visit the SmartBiz Small Business Blog for actionable advice that can help you reach these goals.
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.
** 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.