DSCR vs. FCCR

October 31, 2025

by an investor from New York University in Chicago, IL, USA

We posted this on LinkedIn as well, but I think it's an important concept to share here, given the frequency of post-close liquidity challenges: _________ Debt service coverage can be misleading when fixed costs are high. Most small businesses blend every expense together and buyers say “DSCR = 2.0x — we’re fine.” But if ~50% of your cost base is fixed (rent, leases, insurance, utilities, subscriptions, taxes/fees, pensions, royalties/minimums, etc.), a modest revenue shock hits hard because those fixed costs don’t flex. Quick example: • Base case: DSCR ≈ 2.0x. • Fixed costs and debt service are 50% of revenue • Remaining costs are entirely variable as a percentage of revenue and the company generates 10% EBITDA margins Under this example, a 15% revenue decline turns DSCR into ~1.1x. That’s why segmenting variable vs. fixed costs is critical. While a cost structure high in fixed obligations can look great for margins when revenue is growing, the same cost structure can eliminate the cushion on the way down. A better lens is Fixed Charge Coverage (FCCR). Using the same cost structure above, the base case FCCR is only ~1.2x—a much clearer picture of true headroom and risk. Bottom line: separate fixed from variable, stress-test revenue, and evaluate FCCR alongside DSCR before taking on debt.

Reply by a searcher
from University of Illinois at Urbana in Naperville, IL, USA

That's a good point. I think there are a few of these dimensions that boil down to stress testing and the changing nature of the debt coverage. I think if you take the concept you just explained and then you make sure to run what if scenarios modeled on the expected j curve that you get on revenues as a new owner takes over, that's a good idea. As you model revenues, rather than just examining fixed costs to clarify what absolutely won't reduce, you should also examine variable costs and ask yourself what cost cutting you will do under these conditions. Labor may be considered a variable cost, but there are still key skill sets or individuals that you can't eliminate because you have no redundancy, or situations where an employee is half utilized and you can't cut half of them, etc. So I think it's important to model a downturn and be clear in your own mind what you will do to manage it. I also think it's good and due diligence to ask the current owners how they have handled downturns in the past if the business has enough years on it. If their answer is something like cash in the bank, or there's plenty of cash flow to just go lean for a year or two but they don't have debt service like you will then you better come up with some new ideas. There is something else that's a much longer term concern, but I wonder how often it takes people by surprise. As you pay down whatever debt structure you took out to make the purchase, that payment is slowly converting from mostly interest to mostly principle. As I understand it that means that the cash you pay on that debt service is converting from pre-tax dollars that you can write off to post-tax dollars. Your description may look the say vs. EBITDA, but it certainly looks different versus SDE after tax. Most people either won't look that far ahead or they will reason that by the time that's happening you should have grown enough to be minimizing the debt burden by comparison to the day you bought it. And that certainly is a scenario that you are working for, much you should be prepared for what happens if you don't. Under those conditions you could be 5 or 6 years down the line, maybe you did grow but then you hit a slump either in the business or in the macroeconomics that drive the business, and now you're eating the fixed cost drivers plus the fact that your debt service is not considered dollars you can write off anymore. It's also good to model growth and think about how a revenue drop would feel at different points along the growth curve. The more capital intensive your business, and the bigger the fixed costs ratio to revenue capacity, the more vulnerable you are at certain revenue levels. The day after you buy a new CNC machine and start making the payments your utilization of that asset is pretty low. Hitting a slump right at that moment is it going to leave you holding the bag on more assets than if you hit the slump without that purchase.

Reply by an investor
from McGill University in San Diego, CA, USA

This is bang on and a great observation ^redacted‌. Thanks for sharing. For all those searchers out there that have Ops experience but only modest finance/accounting experience, I highly encourage you to partner with with someone like Sean or Mike who can help you stress test your financial model, a Q of E provider to help you think through how much working capital you need, and if you are buying in an industry you know little about, partnering/hiring an expert to help you assess whether your model's underlying assumptions are realistic.

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