Can Your Business Actually Afford Another Loan?
Banks evaluate whether you have collateral to seize. You must evaluate whether your business generates the free cash flow to repay the loan without strangling operations. Here is the framework.
The collateral illusion
When a lender considers approving a business loan, their primary risk mitigation is collateral: real estate, equipment, or fixed deposits. If the business fails, the bank sells the asset.
Many business owners make the mistake of adopting the bank’s perspective. They think: "I have ₦120 million in land, so borrowing ₦30 million is safe." But land does not generate monthly cash flow. A business cannot pay a ₦1.2 million monthly loan instalment with factory bricks or warehouse property.
Affordability is determined entirely by operating cash flow, never by asset valuation.
The Debt Service Coverage Ratio (DSCR)
Institutional finance uses a simple ratio that every owner-operator should calculate before signing loan documentation: the Debt Service Coverage Ratio (DSCR).
DSCR is calculated as Net Operating Income divided by Total Debt Service (principal plus interest). If your business generates ₦4 million in monthly operating income after costs, and your total monthly loan payments would be ₦3.5 million, your DSCR is 1.14x.
A DSCR of 1.14x means you have virtually zero safety margin. If sales dip by just 12% next month, or diesel prices increase, your business instantly falls into cash deficit.
“Operating with a DSCR below 1.30x leaves a business vulnerable to ordinary economic fluctuations. A single supplier delay or late customer payment causes a missed instalment.”
Stress testing against real-world shocks
Before taking on an additional facility, model three realistic stress scenarios:
Scenario A: Core revenue drops by 15% for three consecutive months.
Scenario B: Input costs or energy prices rise by 20% while pricing remains fixed.
Scenario C: Your largest customer delays payment by 60 days.
If any of these scenarios causes your operating cash to drop below zero while servicing the new loan, the business cannot comfortably afford that debt under its current operational model.
When borrowing is rational vs when it is dangerous
Borrowing to purchase equipment that directly increases production volume with confirmed buyer contracts is productive debt. The asset pays for itself.
Borrowing to cover accumulated operating deficits, uncollected receivables, or speculative expansion without proven demand is defensive debt. Defensive debt almost always increases business fragility.
Don't guess with intuition. Model your numbers.
Test the impact of a new loan against your revenue and expenses before taking on debt. Model it inside BullRock.