Author credentials

I am a CPA and CFP® with 15+ years advising small businesses and preparing loan-ready financials. In my practice I’ve guided more than 500 owners through bank and SBA underwriting; the patterns below reflect how community banks, credit unions, and SBA lenders actually evaluate applications.

Background and context

Underwriting for small commercial loans blends quantitative ratio analysis with qualitative review (industry, management, collateral). While underwriting technology has advanced, core financial ratios remain central because they compress complex financial statements into lender-friendly risk signals. The U.S. Small Business Administration (SBA) and consumer protection resources outline documentation expectations and lender focus areas (SBA, CFPB).

How lenders use key ratios (practical overview)

Lenders look at ratios to answer three basic questions:

  • Can the business generate enough cash to cover debt service? (cash-flow capacity)
  • Is there sufficient collateral or equity if cash flows decline? (loss severity)
  • How much total leverage does the business have relative to owners’ investment? (balance-sheet health)

Because each lender has different risk appetite, a ratio that’s acceptable at an SBA 7(a) lender may be too weak for a regional commercial bank. Many lenders also perform stress tests (e.g., apply a 1.25x coverage test or add interest-rate buffers) to see how the business performs under a downturn.

Key ratios lenders use (formulas, targets, and lender view)

Debt Service Coverage Ratio (DSCR)

  • Formula: Net Operating Income (NOI) / Total Debt Service (principal + interest).
  • Typical target: ≥1.25 for many small commercial loans; conservative lenders may want ≥1.3–1.5. SBA lenders often require demonstrable cash flow and may use adjusted DSCR calculations. (See SBA guidance.)
  • Lender view: A DSCR >1 means positive operating cushion; >1.25 signals room for shocks and covenants are less likely.

Loan-to-Value (LTV)

  • Formula: Loan Amount / Appraised Value of Collateral.
  • Typical target: ≤80% for many asset-backed deals; lower for specialized equipment or vacant commercial property. LTV tolerances vary by asset type and market liquidity. See our guide to LTV for borrower-side tips: Understanding Loan-to-Value (LTV): What Borrowers Need to Know.
  • Lender view: Lower LTV reduces potential loss given default and can lower required guarantees or mortgage insurance.

Debt-to-Income (DTI) — for owner-guaranteed loans

  • Formula: Total Monthly Debt Payments / Gross Monthly Income (often personal, for owner guarantees).
  • Typical target: <35–36% is common for consumer-style underwriting; commercial lenders look at owner DTI when relying on personal guarantees.
  • Lender view: Personal capacity affects willingness to accept business cash flow deficiencies.

Fixed-Charge Coverage Ratio (FCCR) / Interest Coverage

  • Formula (FCCR): (EBITDA + Lease Payments) / (Interest + Lease Payments + Mandatory Principal).
  • Typical target: ≥1.2–1.5 depending on lender and industry.
  • Lender view: Useful when leases or non-debt fixed charges materially affect cash available for debt.

Current Ratio and Quick Ratio (liquidity)

  • Formula (Current): Current Assets / Current Liabilities. (Quick excludes inventory.)
  • Typical target: Current ratio ≥1.0 is a minimum; many lenders prefer >1.2 for small businesses.
  • Lender view: Short-term liquidity matters for working-capital loans or when cash flow is lumpy.

Debt-to-Equity (leverage)

  • Formula: Total Liabilities / Owners’ Equity.
  • Typical target: Varies widely by industry; lenders often flag high leverage (e.g., >2.0) as a concern for small enterprises.

Tangible Net Worth and Minimum Equity Injection

  • Lenders will often require a minimum tangible net worth and proof of owner equity injection (especially for startups).
  • Typical requirement: Specific dollar minimums or percent of project cost on SBA 7(a) or CDC/504 deals.

How ratios feed pricing and covenants

  • Pricing: Lower DSCRs or higher LTVs typically translate to higher interest rates, larger reserves, or upfront fees.
  • Covenants: If ratios are borderline, lenders add covenants (minimum DSCR, maximum capex without approval, cash sweep) to monitor and reduce risk.
  • Guarantees and collateral: Weak ratios often trigger personal guarantees, cross-collateralization, or additional security (UCC filings).

Real-world examples (anonymized)

Example 1 — Café expansion (success)
A café with trailing NOI of $120,000 sought a $150,000 term loan. Debt service on the new and existing debt was $80,000 annually. DSCR = 120,000 / 80,000 = 1.5. The lender approved the loan at a competitive rate with no covenant beyond routine reporting.

Example 2 — Retail store (initial rejection, later approval)
A retail shop showed NOI of $54,000 and debt service of $60,000 (DSCR 0.9). We identified nonessential owner draws and one-time expenses that, when adjusted, raised NOI to $72,000 and DSCR to 1.2. After presenting adjusted, documented financials and a modest owner equity injection lowering LTV, the lender approved financing with conservative covenants.

Operational steps for borrowers (what I do with clients)

  1. Recast financials. Normalize owner compensation, one-time expenses, and related-party transactions to show sustainable NOI. Lenders expect clear, documented adjustments.
  2. Build a simple sensitivity table. Show DSCR at base case, -10% revenue, and +10% costs. Lenders like to see stress scenarios.
  3. Lower effective LTV. Add equity, bring in a co-borrower, or sell nonessential assets.
  4. Improve liquidity. Move to 3–6 months of operating cash reserves or establish a line of credit to smooth seasonality.
  5. Manage personal credit and DTI. Many small-business underwrites hinge on owner credit—repair scores and reduce personal debt where possible.

Quick reference table

Ratio Formula Typical lender target
DSCR NOI / Total Debt Service ≥1.25 (varies by lender)
LTV Loan / Appraised Value ≤80% (asset-dependent)
DTI (personal) Monthly debt / Gross income <35–36%
FCCR / Interest Coverage EBITDA / Interest (plus leases) ≥1.2–1.5
Current ratio Current assets / Current liabilities ≥1.0–1.2

Common mistakes and misconceptions

  • Overstating future revenue without clear drivers. Lenders want credible, documented growth assumptions.
  • Treating ratios as independent. A strong LTV does not compensate for a DSCR below 1.0—both cash flow and collateral matter.
  • Ignoring seasonality. Lenders often annualize results; if your business has seasonal swings, provide monthly bank statements and a line-of-credit plan.
  • Relying solely on one lender’s thresholds. Shop around—community banks, credit unions, and SBA lenders use different overlays.

How lenders stress-test applications (what to expect)

  • Apply a 10–20% haircut to revenue or add an interest-rate buffer (e.g., +200–300 bps) and recalculate DSCR.
  • Require trailing 12 months Bank Statements, tax returns, and profit & loss statements; some lenders prefer internally prepared financials reconciled to tax returns.

How to improve your ratios before applying

  • Reduce discretionary owner draws and defer noncritical capex.
  • Refinance expensive short-term debt to longer amortizations to lower annual debt service and improve DSCR.
  • Bring in equity or a partner to reduce LTV and debt-to-equity.
  • Tighten collections and inventory turns to raise working capital and the current ratio.

Interlinking resources

Frequently asked questions

Q: What DSCR will get me the best rate?
A: Higher is better—1.5+ usually earns stronger pricing. However, exact pricing depends on industry, term, lender size, and borrower profile.

Q: Can I qualify with a DSCR under 1.0?
A: It is difficult. Some asset-based lenders will consider higher LTV or stronger collateral, but most term lenders require DSCR ≥1.0 and prefer a buffer.

Q: Do banks use tax returns or cash accounting?
A: Banks typically want tax returns (business and personal) reconciled to year-to-date financials. Some alternative lenders will focus on bank-statement cash flow.

Professional disclaimer

This article is educational and not personalized financial advice. Underwriting standards vary by lender and change over time. Consult a CPA, commercial loan officer, or SBA-approved intermediary for guidance on your specific situation.

Authoritative sources