By Paul Long |  March 4, 2018

If you are looking for a business loan, making sure you have good credit and have reasonable time in business, then you are on the right track. However, understanding how a bank looks at your financials is another important part of the process. This article is going to show you how you can underwrite your own financial statements when seeking a new loan.


Cash Flow/ Debt Service Coverage:

Before we get into the analysis of the tax return lets evaluate a little about the business.

Paul’s Plumbing currently has the following debt:

Business Credit Card: $4,000 Balance with a monthly payment of: $150.00

Business Auto Loan: $50,000 Balance with a monthly payment of: $432.68

The client is looking for a $50,000 loan for a few new pieces of equipment. The estimated payment will be $966.64

The above tax return for an S-Corp will be used in this analysis example.

First we will look at the cash flow of the business and does the business have enough cash flow to afford his current payments as well as the new loan payment. This process is called finding a business’s Debt Service Coverage Ratio.

First we are going to look at Income/ Cash flow

Total Net Income (Line 21) : $22,111

Note that this number takes into consideration cost of goods sold, rent, salaries, and lunches at fancy restaurants that you “write off” etc.

Add Depreciation (Line 15): $4,500

Depreciation is not an official cash outlay, so it is added back to your net income.

Add the two together to get you cash flow per year to service debt payments of $26,611


The borrower has the following monthly payments:

Credit Card: $150.00

Business Auto Loan: $432.68

Total Monthly payments: $582.68


We are going to take the total monthly payment and multiply it by 12 (months in a year) = $6992.16

Based on the above analysis the business has $26,611 in annual cash flow and has $6992.16 in annual debt payments. Divide $26,611 by $6992.16 and you get = 3.805x. This number reflects that the borrower can service his current debt payments 3.805 times his cash flow.


Now we need to add in the new debt that he would like from the bank using the same exercise:

Credit Card: $150.00

Business Auto Loan: $432.68

Total Monthly payments: $582.68

New Bank Loan: $966.64

TOTAL monthly payments with new bank loan: $1,549.32

We are going to take the total monthly payments above and multiply it by 12 (months in a year) = $18,591.84

With the new bank loan based on the above analysis, the business has $26,611 in annual cash flow and would have $18,591.84 in annual debt payments. Divide $26,611 by $18,591.84 and you get = 1.43x. With this new debt the borrower will now be able to service their current debt and new debt 1.43 times.

Banks will look for 1.25 times or better to approve a loan based on cash flow. The above analysis shows that the borrower passes the cash flow test of underwriting.  Now play with your last tax return and use your debt to calculate your own Debt Service Coverage Ratio.


Business Equity/Balance Sheet


Another important part of the underwriting process is understanding your business balance sheet. Bankers will look at your current cash position, amount of existing debt and the amount of Equity in the company.

Banks need to make sure that the company has equity (It is the difference between what your business is worth (your assets) minus what you owe on it (your debts and liabilities).

Equity is one of the most common issues with smaller businesses due to the business owner taking out all the money out of the company for personal reasons. Banks want to make sure that the business has some skin in the game as well and that that not all of the risk is on the bank/lender. Having negative equity is common in startup businesses, but should get positive over time. In the case below Paul’s Plumbing has $21,950 in business value. The higher this number, the more the bank is willing to lend.

There is a lot more to the loan underwriting process, but coming to the bank with knowledge of these two processes will go a long way in your request.

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