Why capacity is usually understated
Your borrowing capacity is a number someone calculated. Usually wrong, and usually low.
A bank assesses what your business can borrow from the profit figure in front of them. That figure was prepared for the ATO, not for a credit team. It is conservative by design, it carries costs that will never happen again, and it includes rent on premises you are about to stop renting.
None of that is a criticism of your accountant. It is what a set of compliance accounts is for.
But it means the number your bank tested is not the number your business can actually service. An add-back only counts if a credit assessor accepts it, which is a different question from whether it is arithmetically correct. We know which ones survive, because we have sat on that side of the desk and we still speak to those teams every week.
What an add-back is worth
The rate you are quoted is not the rate you are tested at.
A million dollars over 25 years, principal and interest, costs about $88,700 a year at 7.5%. No lender will test it there. At 9.85%, which is where our own calculators assess, the same million costs about $107,800. Then a covenant is applied on top of that.
Every $10,000 of provable earnings is worth $62,000 to $90,000 of property.
So find $50,000 of earnings the last assessment missed, and you have found somewhere between $310,000 and $450,000 of property, depending on where you are tested and what cover the lender wants.
Work it out on your own numbers, free| Tested at | Earnings needed per $1m | $10,000 of earnings buys |
|---|---|---|
| 7.5%, 1.25x cover | $110,800 | $90,000 |
| 7.5%, 1.50x cover | $133,000 | $75,000 |
| 9.85%, 1.25x cover | $134,700 | $74,000 |
| 9.85%, 1.50x cover | $161,700 | $62,000 |
7.5%, 1.25x cover
- Earnings needed per $1m
- $110,800
- $10,000 of earnings buys
- $90,000
7.5%, 1.50x cover
- Earnings needed per $1m
- $133,000
- $10,000 of earnings buys
- $75,000
9.85%, 1.25x cover
- Earnings needed per $1m
- $134,700
- $10,000 of earnings buys
- $74,000
9.85%, 1.50x cover
- Earnings needed per $1m
- $161,700
- $10,000 of earnings buys
- $62,000
Assessment rates, terms, covenants and lender policy vary by deal. These figures illustrate the relationship between earnings and capacity. They are not a quote, a credit assessment or an offer of finance.
What a credit team will accept
| Adjustment | Why a credit team accepts it |
|---|---|
| Depreciation | Non-cash. Standard on any EBITDA-based measure. |
| Rent on premises you are buying | Becomes owner-occupied at settlement. The rent stops and the loan replaces it. |
| Interest on facilities being refinanced | Rolled into the new facility, so it is counted once and not twice. |
| Non-recurring legal costs | A buyout or a dispute that will not repeat. Evidenced by the deed and the invoice. |
| Bad debt from a single customer insolvency | Non-recurring. Evidenced by the administrator's notice. |
| Discretionary superannuation above SG | The owner's election, not an operating cost of the business. |
Depreciation
- Why a credit team accepts it
- Non-cash. Standard on any EBITDA-based measure.
Rent on premises you are buying
- Why a credit team accepts it
- Becomes owner-occupied at settlement. The rent stops and the loan replaces it.
Interest on facilities being refinanced
- Why a credit team accepts it
- Rolled into the new facility, so it is counted once and not twice.
Non-recurring legal costs
- Why a credit team accepts it
- A buyout or a dispute that will not repeat. Evidenced by the deed and the invoice.
Bad debt from a single customer insolvency
- Why a credit team accepts it
- Non-recurring. Evidenced by the administrator's notice.
Discretionary superannuation above SG
- Why a credit team accepts it
- The owner's election, not an operating cost of the business.
And what will not go in.
- Personal expenses run through the business, however they are described
- Owner's discretionary claims with nothing behind them but the owner
- Anything a credit assessor cannot open a source document against
Every adjustment we make traces to a source document, and we prepare the file expecting it to be challenged, because that is how these are actually read. When an adjustment will not survive, we say so before it goes in. A submission that gets pulled apart at credit costs you more than the capacity you were reaching for.
On a real file
The self storage deal the bank said would not service
The largest add-back most files will ever carry is the one the transaction creates: rent on premises the business is about to own.
A going-concern purchase of a storage business together with the freehold it sits on, a little over $3.5m combined. On the vendor's accounts the bank was right to decline it: the business sat below 1.0x debt service cover, and an application built on those accounts was never going to pass.
Two things were sitting in plain sight. The business had been paying well over $150,000 a year in rent to the vendor's family trust, which owned the freehold, and the buyer was purchasing the freehold too. From settlement day that rent stops being a cost and becomes the loan. Separately, the buyer ran an established business of his own, and those earnings belonged in the servicing picture. We adopted them at a discount to the recent average and never counted anything twice.
The rent normalisation was evidenced from both sides, the operating accounts and the property trust's rental statements, and the whole structure was covenant tested at sensitised rates before it went anywhere. An additional $3m in lending approved.
Photograph shared with the client's permission. Figures materially altered. Outcomes depend on individual circumstances and lender criteria.
Where this gets done
Reading about it is free. So is the first call.
Everything on this page is the method, and you are welcome to run it yourself against your own accounts. Where you want it done properly, the Debt Capacity Assessment is the engagement: every adjustment evidenced from source documents, covenant tested at the assessment rate, and a written read on what the numbers actually support. It is free for clients of The Lending Lab and a fixed fee for everyone else.
Two ways this can work.
Referred to us for finance? You are in the right place either way. Either we arrange it, or we prepare the file for whoever does.
Have us arrange the finance
We build the analysis, write the submission and take it to the lenders who will actually do the deal, across 40+ of them. One team from the first set of figures to settlement, and one team holding the covenants after it.
Start a finance enquiryAlready have a broker or a banker you trust?
Keep them. We will build the file to the standard a credit team expects and work directly with whoever lodges it. Same models, same documents, same standards, and we do not take the lodgement on that engagement.
See the finance documentsWant a straight read on your deal?
Book a free call with Nick. Bring the numbers you have, and we will tell you the right service level and the fixed fee. No obligation.