Cash flow cover: can your business afford the loan repayments?

Short answer: cash flow cover (also called debt service cover, or DSCR) tells a lender how many times your business’s spare cash covers its loan repayments for a year. The usual formula is cash available for repayments ÷ yearly repayments (interest plus principal), where cash available is EBITDA (profit before interest, tax, depreciation and amortisation) less tax paid and less what the owners take out that is not already in the wages. A business with $108,000 of cash available and $48,000 of repayments a year has cash flow cover of 2.25 times. Loan covenants usually set a minimum, often somewhere around 1.25 to 1.5 times, and the loan offer states the exact figure and how the lender calculates it. Below 1.0 times, the repayments cannot be paid from trading. Work it out before you apply, including the new loan, because the worked example below shows how a ratio that looks comfortable today can end up with almost no headroom.

The cash flow cover formula

Line	What it is
EBITDA	Net profit before tax + interest + depreciation and amortisation
less tax paid	Company tax or income tax actually paid in the year
less owner drawings or dividends	Money the owners took out that is not already a wage in the Profit and Loss
= Cash available for repayments	Sometimes called CFADS, cash flow available for debt service (how to work out CFADS)
Yearly repayments	Interest + principal on every loan, hire purchase and equipment finance for the year
Cash flow cover	Cash available ÷ yearly repayments, written as “2.25x” or “2.25 times”

Lenders differ in the detail. Some leave out drawings, some take off a “maintenance” amount for equipment you will have to replace, some include lease payments, and some add back one-off costs. Ask which definition your loan offer uses and work yours out the same way, because a covenant is tested on the lender’s definition, not yours.

Interest cover is a different, easier test: EBIT ÷ interest, where EBIT is profit before interest and tax. It ignores the principal, so it usually looks much healthier than cash flow cover. Most small business loans are mostly principal, which is why cash flow cover is the one to watch.

A worked example: an electrical contractor in Brisbane

These figures are made up. Priya’s electrical contracting company wants to borrow $150,000 for a new service truck and test equipment. Its year ends on 30 June. Every figure is in Australian dollars without GST, and Priya and her co-director are paid wages through payroll, so their pay is already in the Profit and Loss.

Year to June 2026	$
Net profit before tax (Xero’s Net Profit)	140,000
add back interest on the existing equipment loan	12,000
add back depreciation	22,000
EBITDA	174,000
less company tax paid	(31,000)
less dividends paid to the directors	(35,000)
Cash available for repayments	108,000
Existing loan repayments (12,000 interest + 36,000 principal)	48,000
Cash flow cover today	2.25x

Brackets are minus figures. 108,000 ÷ 48,000 = 2.25 times. On its own that looks comfortable.

Adding the new loan

The bank offers $150,000 over 5 years at 9% a year, repaid monthly. That is $3,113.75 a month, or $37,365 a year (about $12,491 of interest and $24,874 of principal in the first year).

• Repayments become 48,000 + 37,365 = $85,365 a year.
• Cash flow cover becomes 108,000 ÷ 85,365 = 1.27x.
• If the covenant is 1.25x, the business needs at least 1.25 × 85,365 = $106,706 of cash available. It has $108,000, so the headroom is only $1,294: EBITDA can fall by less than 1% before the covenant is breached. The bank tests on last year’s figures, so the extra work the new truck should bring does not count yet.
• A year 10% worse (EBITDA down $17,400 to $156,600) gives 90,600 ÷ 85,365 = 1.06x, a breach, even though the business would still be profitable and still paying every instalment on time.

Interest cover, meanwhile, says everything is fine: EBIT is 140,000 + 12,000 = $152,000, and 152,000 ÷ (12,000 + 12,491) = 6.2 times. That gap is the whole reason to work out cash flow cover yourself.

Three ways Priya could make it safer

Option	Yearly repayments ($)	Cash available ($)	Cash flow cover	In a 10% worse year
As offered: 5 years	85,365	108,000	1.27x	1.06x
Ask for 7 years ($2,413.36 a month)	48,000 + 28,960 = 76,960	108,000	1.40x	1.18x
Keep 5 years, cut dividends to $20,000	85,365	123,000	1.44x	1.24x

A longer term costs more interest in total, and lower dividends mean less for the directors, so neither is free. But either gives the business room for an ordinary bad year without a covenant breach, which can let the bank reprice the loan or ask for more security. Borrowing less, or paying part of the truck from cash the business does not need for its low point (see cash flow loan and how many months of cash a business should have), works too.

How to work out your cash flow cover in Xero

1. Run Accounting › Reports › Profit and Loss for the last 12 months (or the last financial year, if that is what the lender will test). Note Net Profit, the interest expense and the depreciation expense, and add them up to get EBITDA. The EBITDA calculator does this step.
2. Find tax paid and owner drawings or dividends. Run the Account Transactions report for your tax, drawings and dividend accounts, or check the payments on the Statement of Cash Flows (how to read it).
3. Add up a year of repayments for every loan, hire purchase and equipment finance agreement. Your loan statements are the most reliable source. In Xero, the principal is the fall in each loan’s balance on the Balance Sheet over the year, and the interest is in the Profit and Loss.
4. Divide cash available by yearly repayments. Then do it again with the new loan’s repayments added, which is the figure the lender will look at. The debt service coverage ratio calculator does both, and shows the largest loan that still passes 1.25x at the rate and term on offer.

Menu names move between Xero releases and regions, so search Xero Central for the report name if your screen differs. If a lender quotes a covenant, ask for the definition in writing and keep a copy beside the calculation.

Common mistakes

• Using interest cover instead. It leaves out principal, so a business can have 6 times interest cover and barely 1.25 times cash flow cover.
• Forgetting drawings. For a sole trader or partnership, the owner’s pay is not in the Profit and Loss. Take it off, or the ratio flatters the business.
• Leaving out hire purchase and equipment finance. Every agreement with a monthly repayment counts, not just the bank loan.
• Using one good month times twelve. Use a full year, because the lender will.
• Counting the new loan’s earnings before they exist. The covenant is tested on actual results, so plan on the business as it is today.
• Checking once. Covenants are usually tested every year, or every quarter on a rolling 12 months. Recalculate after each quarter’s figures are done, so a squeeze shows up before the bank sees it.

Common questions

What is cash flow cover? It is a ratio that shows how many times a business’s spare cash covers its loan repayments over a year. Divide cash available for repayments (EBITDA less tax paid and owner drawings) by the year’s interest and principal repayments. A cover of 2 times means the business generated twice what its loans cost to repay.

How do you calculate cash flow cover? Start with EBITDA, take off tax paid and any drawings or dividends that are not already wages, then divide by a year of loan repayments, counting both interest and principal. For example, 108,000 of cash available and 85,365 of repayments gives 1.27 times.

What is a good cash flow cover ratio? Lenders often set a minimum somewhere around 1.25 to 1.5 times in their covenants, and the loan offer gives the exact figure. Below 1.0 times, the repayments cannot be met from trading. Aim for enough headroom that an ordinary bad year, say 10% lower earnings, would still pass the covenant.

Is cash flow cover the same as DSCR? Usually, yes. Debt service cover ratio and debt service coverage ratio are other names for the same idea: cash available for debt service divided by debt service. Lenders word the definition differently, so check which items yours includes.

What is the difference between cash flow cover and interest cover? Interest cover divides profit before interest and tax by the interest alone. Cash flow cover divides cash available by interest and principal together. Because most small business loan repayments are mainly principal, cash flow cover is the stricter test.

What happens if I breach a cash flow cover covenant? It depends on the loan agreement. The lender may ask for a plan, charge a fee or a higher rate, ask for more security, or in serious cases call the loan in. Talk to the lender early if your own calculation shows you are close, because a breach found at the annual review leaves fewer options.

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