Mostly one ratio and one document. The ratio is your debt service coverage, which is the cash your business produces in a year divided by the loan payments it owes that year, figured the bank's way with the bank's adjustments. The document is your work-in-progress schedule, the job-by-job report that shows what you've billed next to what you've actually built. You can work out both months before you ask for the money, and I think every contractor should, because by the time you sit down with your banker most of the answer is already in the file.
A lot of owners expect the meeting to turn on revenue and how long they've banked there. I understand why, and the relationship helps at the edges, but most of the decision rests on arithmetic you can do yourself.
The ratio the bank cares about most
Debt service coverage ratio, or DSCR, tells the bank how many dollars of cash the business produces for every dollar of loan payments it owes this year. You divide the year's cash generation by the year's total debt payments, principal and interest together, truck loans and equipment notes included.
Here's a simple version, with round illustrative numbers, not a client. Say a contractor doing about $4 million a year generates $320,000 of cash and owes $180,000 in payments on its equipment notes and truck loans. That works out to 1.78, and most bankers would be comfortable there.
Now say a thinner year follows. Cash generation drops to $240,000, and the company has financed two more machines, so payments climb to $200,000. The ratio falls to 1.20, and at that level the answer might be no, or a yes that comes with a higher rate and a personal guarantee you won't enjoy signing.
A common floor many lenders use is 1.25, though it varies by bank and by loan type, and some lenders accept less. Below 1.0 the business doesn't produce enough cash to cover its own loan payments, and right at 1.0 every dollar is spoken for, so one general contractor who pays slow can put you behind.
The bank figures it differently than you do
Owners are usually surprised by this. The number on your own P&L usually won't match the bank's, because the bank adjusts your numbers before it runs the ratio.
Owner pay is a big one. Many lenders adjust what you pay yourself to a market-rate salary, roughly what it would cost to hire someone to do your job, and that can move things in either direction. If you've been paying yourself light, the adjustment adds a cost your P&L never showed and lowers the cash they count toward loan payments.
Some lenders also take out distributions, and some take out equipment you paid cash for, since money spent on a truck wasn't there for loan payments. Working in your favor are add-backs, expenses on the P&L that didn't cost you cash that year. Depreciation is the usual example, and many lenders put it back in, though each handles it a little differently.
So a good year on the P&L can still come back from the bank as a ratio well below what the owner expected, and if nobody explains why, a turndown can feel like it came out of nowhere.
The document that matters for contractors
Contractors have one more document that carries a lot of weight, and plenty of owners treat it as year-end paperwork. That's the WIP schedule, short for work in progress, a list of every open job with the contract amount, the cost so far, how far along it is and what you've billed.
A lender who knows construction reads it closely, and billing is where I'd expect them to look first. Underbilling means you've done work you haven't invoiced yet, so the crew and the supplier are paid and the cash is waiting on you to send the bill. To a lender that looks like strain on working capital (the cash you run the business on day to day), and it can make the line look like a patch for a billing problem. Overbilling, billing ahead of the work, isn't automatically good news either, because it can mean you're running on customer money, which works fine until a job stalls. If that sounds familiar, it's the same timing gap behind why profitable contractors still run out of cash.
They'll also look at how your margins hold up from job to job, since steady gross margin suggests you know how to bid and big swings can mean some jobs are carrying others. Backlog, the signed work you haven't done yet, matters too, because it's about the closest thing a bank has to evidence of next year's work.
And they'll check whether the totals on your job report match the books. A banker who finds a gap there may never bring it up with you, but it can still show up in the terms you're offered.
You can see all of this coming
What frustrates me is how avoidable the surprise is. DSCR is arithmetic on numbers you already have, and the WIP schedule is a report on your own jobs, yet owners still tend to find out where they stand the week of the meeting because nobody is checking on a regular schedule.
If you run the ratio in March and see it drifting toward 1.20 by fall, you have room to act. You might restructure a note or hold off on a piece of equipment, get billing current so underbilled jobs stop piling up, and set owner pay on purpose. Those changes can take several months or longer to show up in the results a lender reviews, which often include two or three years of tax returns or statements plus your most recent numbers, so I like to see owners start well ahead of the meeting.
A checklist for 6 to 12 months out
- Figure your DSCR the bank's way, with owner pay set to a market-rate salary, and with distributions and equipment bought with cash taken out, since some lenders do that.
- Run it every quarter so you can see which way it's moving.
- Get the totals on your WIP schedule matching your books every month.
- Look at whether you're billed ahead of or behind the work overall, and fix chronic underbilling in your billing process.
- Decide owner pay with the ratio in mind.
- Ask your banker what covenants would come with the line. Covenants are ongoing rules in the loan agreement, such as a minimum coverage ratio or working capital level, so the ratio keeps mattering after you sign.
This is a normal part of my work with skilled trades and construction owners, because the numbers a bank uses are the ones I'd want an owner watching every month anyway. You can see how I work here.
FAQ
What DSCR do lenders usually want? A common floor many lenders use is 1.25, though it varies by bank and loan type, and some lenders accept less.
Why would a profitable contractor get turned down for a line of credit? Often because the bank's adjusted cash flow comes in lower than the profit on the P&L. Adjusting owner pay to a market-rate salary can lower it if you've paid yourself light, and some lenders also take out distributions and equipment bought with cash.
Why does my bank want my WIP schedule? It shows which jobs are billed ahead of or behind the work and whether your margins are holding up job to job, which the financial statements alone don't show.
How long does it take to fix a weak coverage ratio? It can take several months or longer, because the changes have to show up in the results a lender reviews, which often include two or three years of tax returns or statements plus your most recent numbers.
If you're thinking about asking for a line sometime in the next year, these numbers are worth a look whenever you get to them. If you'd like a second set of eyes, you can reach me here, and the FAQ covers how I work and what it costs.