The one question every ratio answers: can this business generate enough cash to cover its obligations, with room to spare? Lenders don’t lend against revenue or even profit. They lend against the ability to service debt. Coverage ratios are how they measure it, and knowing them lets you check your own file before anyone else does.

DSCR: Debt Service Coverage Ratio

DSCR is the headline ratio. It compares the cash a business produces to the debt payments it owes.

DSCR = Net Operating Income / Total Debt Service

Net operating income is roughly your EBITDA (earnings before interest, taxes, depreciation, and amortization), and total debt service is the principal plus interest due over the period. A DSCR of 1.0× means the business generates exactly enough to cover its debt payments, with nothing left over. That’s not comfort, that’s the edge of a cliff.

  • Below 1.0×: the business isn’t producing enough cash to cover debt. A decline in almost every context.
  • 1.0× to 1.25×: thin. Some lenders will do it with strong collateral, but there’s little margin for a bad quarter.
  • 1.25× to 1.50×: the common comfort zone. Many lenders set a 1.25× minimum covenant.
  • Above 1.50×: healthy cushion, better terms, more borrowing capacity.

FCCR: Fixed Charge Coverage Ratio

FCCR is DSCR’s stricter cousin. It recognizes that debt payments aren’t a company’s only unavoidable obligations. Lease payments, for example, are just as mandatory as loan payments, and a business heavy on operating leases can look fine on DSCR while being genuinely stretched.

FCCR = (EBITDA − Unfinanced CapEx − Cash Taxes − Distributions) / (Debt Service + Lease Payments + Other Fixed Charges)

The exact formula varies by lender, but the idea is constant: put all the fixed, must-pay charges in the denominator, and count only the cash genuinely available to cover them in the numerator. FCCR is why two companies with identical DSCRs can get different answers. The one with heavy leases, required capital spending, or owner distributions has less real cushion, and FCCR exposes it.

The adjustments that change the answer

Coverage ratios look objective, but the inputs are where the real negotiation happens. A credit team scrutinizes:

  • EBITDA addbacks. Owners add back expenses to inflate earnings and improve the ratio. Which addbacks survive diligence and which don’t is its own discipline; we cover it in addbacks that survive vs. addbacks that don’t. Every questionable addback that gets stripped out lowers your coverage.
  • Unfinanced CapEx. If the business must spend on equipment just to keep running, that cash isn’t available for debt service, and a careful lender subtracts it.
  • Owner distributions. In closely held businesses, distributions the owner treats as necessary income reduce the cash truly available to creditors.
  • Normalized vs. trailing. Is the ratio calculated on a good trailing year, or on a normalized figure that reflects the real run rate? A ratio built on a peak year overstates coverage.

The number you calculate with generous inputs and the number a credit team calculates with conservative ones can be a full turn apart. That gap is often the whole underwriting conversation.

How to use these ratios on your own file

Before you approach a lender, run both ratios the way they will:

  1. Start from clean, defensible EBITDA, not your most optimistic addback stack.
  2. Subtract the cash that genuinely isn’t available: required CapEx, cash taxes, distributions you actually take.
  3. Put all fixed charges in the denominator for FCCR, leases included.
  4. Compare the result to a 1.25× yardstick. If you’re below it on honest inputs, you know the conversation before you walk in, and you can either strengthen the file or size the request to what the coverage supports.

Coverage ratios aren’t a lender’s trick. They’re the most honest one-line summary of whether debt is safe for both sides. Knowing yours, calculated conservatively, is the difference between negotiating from knowledge and getting surprised.

Run your own file first

Want your DSCR and FCCR calculated the way a credit team would, addbacks and all? Run the assessment or send us your financials and we’ll show you the real numbers.

Educational only. Nothing here is an offer of credit, a commitment to lend, or advice on any specific transaction.