Determining the debt-to-income (DTI) ratio for your small business is an important way to assess the financial health and sustainability of your company. The DTI ratio compares how much debt your business has to its income, giving you and potential lenders a snapshot of your business’s ability to take on additional debt.
The debt-to-income ratio is a simple calculation that divides your business’s total monthly debt payments by its total monthly income. It is usually expressed as a percentage. For example:
Total Monthly Debt Payments = $5,000
Total Monthly Income = $10,000
DTI = Total Monthly Debt Payments / Total Monthly Income
= $5,000 / $10,000 = 50%
So this fictional company has a debt-to-income ratio of 50%.
The DTI ratio is an important metric because it shows how easily your business can handle taking on more debt. A higher DTI ratio means your business is already dedicating a large portion of its income to paying off debts, leaving less flexibility to take on additional financing.
Lenders usually look for a DTI ratio under 50% when considering loan applications. A ratio higher than that often makes lenders cautious about lending more money.
So calculating your small business’s DTI ratio periodically lets you see how much additional debt your current income could reasonable handle. It’s an important data point as you consider business growth plans or equipment purchases that might require financing.
Figuring out your small business’s debt-to-income ratio involves just three steps:
First, make a list of all your business’s current monthly debt payments. This includes:
Add up all those monthly payments to get your total monthly debt payments.
Next, determine your business’s total monthly income.
Let’s say our fictional business has $15,000 in total monthly income.
The final step is to divide your total monthly debt payments by your total monthly income to get your DTI percentage:
Total Monthly Debt Payments = $4,750
Total Monthly Income = $15,000
DTI Percentage = Total Monthly Debt Payments / Total Monthly Income
= $4,750 / $15,000 = 32%
So this fictional small business has a debt-to-income ratio of 32%.
As mentioned earlier, lenders usually look for a DTI under 50%. The lower your ratio, the less financial risk you pose to potential lenders.
Good DTI ratios for small businesses generally fall into these ranges:
Of course, every lender has their own standards and special situations exist. But those ranges give you a general guideline.
Aim to keep your small business DTI ratio under 40% whenever possible. Then you’ll have financial flexibility to take advantage of growth opportunities in the future.
If your debt-to-income ratio seems dangerously high, here are some tips to improve it:
The key is analyzing your finances to find the best opportunities to reduce total monthly debt payments and improve cash flow. Then you can directly lower your DTI ratio.
Assessing your small business’s DTI ratio should be part of your regular financial analysis process. It’s a metric you can track over time to gauge improving or worsening financial health.
It also provides data to inform all kinds of business decisions like:
So be sure to calculate your DTI ratio at least quarterly, if not monthly. Trends in that key metric will influence the way you steer your small business.
While debt-to-income ratio should be part of your regular analytics, it doesn’t provide a full picture of financial health on its own. Some other key small business financial ratios you should calculate include:
Profit Margin – Shows what percentage of total sales are actual profit. Helps gauge pricing and profitability.
Return on Investment (ROI) – Compares earnings to capital invested in the business. Checks if you’re getting enough bang for your buck from investments.
Current Ratio – Helps assess ability to pay short-term liabilities. You want more current assets than current liabilities.
Cash Flow – Looks at the actual cash you generate and use in your business monthly. Helps predict ability to pay expenses.
Use a mix of financial ratios to assess all different aspects of your business operations and financial fitness. DTI ratio is one important piece of that overall analysis.
If your DTI ratio is very high or you need help structuring loans and payments, don’t hesitate to seek assistance from financial professionals. Most small business owners work with:
The right financial professionals make calculating key ratios simple and support you in making strategic business decisions based on those metrics.
As you saw in this article, determining your small business’s debt-to-income ratio is straightforward. Simply:
Regularly monitor trends in your DTI ratio, as well as other key financial metrics, to gauge the financial fitness of your business. Use those numbers to strategically guide business decisions and financing plans.
Keeping your debt-to-income ratio in the optimal range gives your small business resilience and room to seize growth opportunities when they arise. So be sure to calculate your DTI regularly and seek professional support if you need help improving it over time.
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