Debt-to-Income Ratio (DTI) or debt-to-earnings ratio refers to the percentage of a business’s gross monthly income (pre-taxes) devoted to paying its existing debts.
To compute a company’s debt-to-income ratio, add up all of its monthly debt payments- this may include commercial real estate loans, lines of credit, equipment leases, business vehicle loans, and minimum business credit card payments- and divide the sum by its monthly gross income. For example, if your business generates $40,000 monthly, and your total monthly payments are $4,000, your DTI ratio will work like this:
$4,000/ $40,000 × 100= 10% DTI
The formula to calculate the debt-to-income ratio is:
DTI= Total Monthly Debt Payments/ Gross Monthly Income ×100
The DTI is used by lenders when deciding whether to provide a company with a loan because it shows what amount of their profits is currently used to service existing loans. This helps the lender determine a business’ ability to repay monthly payments and accumulate additional debt. Generally, an acceptable debt-to-income ratio should sit at or below 36% for a small business.
A low debt-to-income ratio demonstrates a good balance between debt and income. In other words, if a company’s DTI is 10%, it means that 10% of its monthly earnings go to debt payments each month. On the other hand, a high debt-to-income ratio (above 36%) is an indicator that a firm has too much debt for the amount of money it earns every month. Consequently, lenders want to see low DTI ratios before issuing a loan to a client because it is a sign that they manage their monthly loan payments and other debt obligations effectively.
Learning how to determine and improve your company’s debt-to-income ratio will help you understand your current loan commitments.
As a small business, there are several ways to lower your DTI ratio, including but not limited to:
- Pay off debts faster.
- Consolidate your debts.
- Increase monthly gross earnings.