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Calculating the Debt-to-Income Ratio for Your Small Business

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.

What is the Debt-to-Income Ratio?

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, if your business has $5,000 in monthly debt payments and $10,000 in monthly income, your DTI would be 50% ($5,000/$10,000).

The higher your business’s DTI ratio, the more loaded down with debt payments it is each month relative to its income. Most lenders prefer to see a DTI of 50% or less when considering business loans. A high ratio over 80-90% may make it difficult for your business to qualify for additional financing.

Why Calculate Your Business’s DTI?

There are a few key reasons to know your small business’s debt-to-income ratio:

  • Assess financial health: Your business’s DTI helps you evaluate its ability to manage additional debt. A lower ratio gives you more flexibility, while a higher ratio indicates your business is heavily burdened by current debts.
  • Qualify for financing: When applying for small business loans, lenders will look at your DTI to determine if your business can handle taking on additional financing. A lower ratio can improve your chances.
  • Compare over time: Tracking your DTI every month or quarter lets you monitor trends over time. An increasing ratio could signal problems managing your debts.
  • Benchmark against industry averages: Knowing typical DTI ratios in your industry provides context for evaluating your business’s ratio.

How to Calculate DTI for a Small Business

Figuring out your small business’s debt-to-income ratio involves tallying all monthly debt payments and dividing them by total monthly income. Here are the key steps:

  1. Determine monthly debt payments – Tally the monthly payments due on all business debts like loans, lines of credit, credit cards, equipment leases, and merchant cash advances. Do not include one-time or irregular expenses.
  2. Calculate total monthly income – Add up all reliable revenue your business brings in each month, such as from sales, services, and any rental income. Be conservative to avoid inflating your income.
  3. Divide total debt by total income – Take your total monthly debt payments and divide it by your total monthly income to get your DTI percentage.

For example, if your business has:

  • $3,000 monthly loan payment
  • $1,000 monthly line of credit minimum
  • $500 monthly equipment lease payment
  • $4,500 total monthly debt payments

And your average monthly income over the past year is $10,000.

Your DTI would be $4,500 (debt) divided by $10,000 (income) = 45%

What is a Good DTI for a Small Business?

Most lenders prefer to see a DTI at 50% or below when considering a small business loan application, though requirements can vary.

Good DTI ratios for small businesses generally fall into these ranges:

  • Very Good: under 30%
  • Safe: 30-50%
  • Caution: 50-80%
  • High-risk: over 80%

A ratio over 90% will likely cause problems qualifying for any new financing.

Service-based businesses may be able to justify higher DTIs since they have less infrastructure costs. Capital intensive businesses like manufacturers usually can’t exceed 80% without running into issues.

Compare your ratio to average industry DTIs to better gauge how your business is performing. For example, the average DTI in the restaurant industry is around 55-60%.

Tips for Improving Your Business’s DTI

If your small business’s debt-to-income ratio seems high, here are some tips to improve it:

  • Pay down balances – Attack high-interest debt first to quickly reduce monthly payments.
  • Renegotiate terms – Talk to creditors about extending terms to reduce monthly debts.
  • Lower expenses – Reduce overhead costs so more income can go toward debt payments.
  • Increase sales – Focus on boosting monthly revenue through additional sales and services.
  • Refinance debt – Combine multiple debts into a new lower payment at a lower rate.

With some adjustments, you may be able to reduce your DTI substantially in 6-12 months to qualify for loans. Just be sure additional financing aligns with your business goals and doesn’t overburden the company long-term.

Keeping an eye on your DTI each quarter and having a plan to keep it at 50% or under will ensure your small business stays financially healthy as it grows.

Additional Small Business Debt-to-Income Ratio Resources

For more help assessing and improving your small business DTI ratio, check out these useful resources:

Tracking your debt-to-income ratio provides valuable insight into the financial position of your small business so you can set it up for sustainable success.

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