Answers ~6 min read Updated
How Much Can My Business Borrow? How Banks Size a Loan
Banks size a business loan from your cash flow first, then check it against collateral. Here is the simple math a lender uses, with a worked example.
Banks size a business loan from your cash flow first. The common rule: your cash flow should cover all of your loan payments at least 1.25 times. So divide your cash flow by 1.25, subtract the payments you already make, and what's left is the most new yearly payment a bank will usually approve. Then the bank checks that against your collateral.
Revenue doesn't decide it. Cash flow does. A business with $5 million in sales and thin profits can qualify for less than a $2 million business with strong margins.
The bank's math in three steps
Step 1: Find your cash flow. Start with EBITDA (earnings before interest, taxes, depreciation, and amortization). Then subtract what the owners take out in distributions.
Step 2: Find your payment room. Divide cash flow by 1.25, then subtract your current yearly loan payments.
Step 3: Turn payment room into a loan amount. The rate and term decide how much loan that payment can support.
A worked example
| Step | Amount |
|---|---|
| EBITDA | $400,000 |
| Less owner distributions | – $100,000 |
| Cash flow the bank counts | $300,000 |
| Divide by 1.25 = most total yearly payments | $240,000 |
| Less payments you already make | – $90,000 |
| Room for new yearly payments | $150,000 |
At 8% interest, $150,000 a year in payments supports about $1,030,000 over 10 years, or about $800,000 over 7 years. Same business, same cash flow. The term changed the answer by more than $200,000.
Your debt service coverage
1.50×Excellent debt service coverage ratio
Strong coverage. At 1.50× and up, you’re in line for better pricing and more flexibility.
Collateral sets the second limit
Even if cash flow supports a big loan, the bank also asks what secures it. Lenders lend a percentage of each asset's value, called the advance rate:
- Cash and CDs: 90% to 100%
- Receivables under 90 days: 70% to 80%
- Inventory: 20% to 50%
- New equipment: 70% to 80% of cost
- Owner-occupied real estate: 75% to 85%
The loan usually ends up at the lower of the two numbers: what cash flow supports and what collateral covers. SBA loans can help when collateral comes up short.
Run your own numbers
Plug your figures into the How Much Can I Borrow? calculator to test different rates and terms. For the full set of ratios banks check, read Chapter 3. For advance rates and loan structures, see Chapter 7.
Common questions
How much of a business loan can I get?
Most banks size a loan so that your cash flow covers all of your loan payments at least 1.25 times. Divide your cash flow by 1.25, subtract the loan payments you already have, and the rest is the most new annual payment the bank will usually approve.
Do banks lend based on revenue?
Not directly. Banks lend based on cash flow, meaning what is left after expenses. Some online lenders and merchant cash advance companies lend based on revenue, which is one reason they cost more.
How does the loan term change how much I can borrow?
A longer term means a smaller payment for each dollar borrowed, so the same cash flow supports a bigger loan. In our example, the same $150,000 of yearly payment room supports about $1.03 million over 10 years but only about $800,000 over 7 years.
How do banks size a line of credit?
Banks usually start with a borrowing base: about 75% to 80% of receivables under 90 days old, plus 20% to 50% of inventory. The line is set at or below that number.