What is the Debt-to-Income Ratio for Small Business Loans?

What is the Debt-to-Income Ratio and How is it Used?

The Debt-to-Income Ratio (DTI), also known as the Debt-to-Earnings Ratio, shows how much of your small business’s monthly earnings go to repaying your existing debts. The DTI is one of the measures used by lenders when deciding whether to provide your business with a loan. 

Learning how to calculate and optimize your business’s DTI will help you understand your current loan commitments. This is good-to-know information in general, but is especially helpful when it comes time to secure financing, as knowing your DTI can maximize your acceptance rate as well as help you get more favorable terms.

What is the Small Business Debt-to-Income Ratio?

The DTI compares your total “gross monthly earnings” to your total monthly repayments that you make to settle existing loans and debts. The DTI shows the proportion of your profits that are currently being used to service existing loans. This helps demonstrate how affordable new debt repayments are likely to be, and your business’s likelihood to meet those commitments. It is normally shown as a percentage.

As an example, if your DTI ratio is 30 percent, then 30 percent of your gross monthly small business profits are going towards repaying your debt each month.

What Are Gross Monthly Earnings?

Your gross monthly earnings, also known as your gross monthly income or gross monthly profits, is your business’s monthly revenue less the cost of selling goods and services (Cost of Goods Sold, or COGS). Your gross monthly earnings do not typically take your fixed charges into account. Importantly, your gross monthly earnings do not include taxes you or your business may pay on those earnings.

What Are Total Monthly Repayments?

Your monthly repayments are the combined total of installments and repayments you make to reduce your existing business loans. These repayments include amounts you pay to repay interest charged, the original capital, and service fees. These repayments may be for regular debt, mortgage debt, rents and leases, credit card debt, and other ongoing loans. 

How Do I Calculate My Small Business Debt-to-Income Ratio?

Firstly, you will need to gather some information:

  • Calculate your total gross profits.
  • Add together all of your small business monthly debt repayments to get a total amount.

Next, you can calculate your small business DTI ratio as follows:

  1. Use the sum of your monthly debt repayments.
  2. Divide this total amount by your small business monthly gross profits.
  3. Multiply the result by 100.
  4. The result is your DTI ratio percentage.

Here’s an example:

  • Gross monthly profits: $12,000
  • Total loan repayments: $3,500
  • DTI ratio: 29.2% ($3,500 / $12,000 X 100)

Is a High or Low Debt-to-Income Ratio Better?

The lower your DTI ratio, the better. Low DTI ratios mean that less of your earnings are going towards repaying your loans—so your small business has additional funds that can go towards new debt and repayments. Having a lower DTI ratio means your small business is more likely to be accepted for a loan.

What is an Ideal Small Business Debt-to-Income Ratio?

Your small business DTI ratio should be below 50 percent if you want to be considered for a loan. This means that less than half of your profits are being used to repay debt. To maximize your chances of loan acceptance, aim for a DTI ratio of 36 percent or less—the lower the better.

How Do Lenders Use the Debt-to-Income Ratio?

A lender uses the DTI ratio, along with other financial measurements, to understand how likely your business is to repay money they lend you. This helps them minimize their risks. 

For lenders, the DTI ratio is only one indicator of how likely they are to have a loan repaid. Businesses with a low DTI have less of their profits currently committed to repayments, meaning there’s more cash free to finance new loans that can help grow your business. Lenders don’t use the DTI ratio in isolation—it’s just one indicator of the financial health of a business.

What Are the Limitations of the Debt-to-Income Ratio?

Although the DTI ratio is a helpful indicator, there are some things that it won’t tell you or a lender:

  • The percentage of your total credit limit or credit capacity that you’re actually using
  • The interest rates that you’re paying on your debt
  • The cash flow in your business
  • The overall profits, losses, and expenses of your business
  • The total amount of your fixed charges and your ability to meet them

Lenders will use these measures, together with your personal or business credit score and other factors to decide whether to lend to you. 

How Can Company Management Use the Debt-to-Income Ratio?

Your DTI ratio isn’t just used when applying for loans—it can also tell business owners and other stakeholders important financial information about your business, specifically:

  • Are your monthly profits high enough to comfortably meet debt repayments?
  • What capacity does your business have to take on new loan repayments?
  • How easy will it be to finance growth or other business needs?
  • Does your business need to focus more on maximizing profits and reducing total repayments?

How Can I Improve my Debt-to-Income Ratio?

There are two main ways to get a lower DTI ratio:

  1. Increase monthly gross profits.
  2. Reduce total monthly loan repayment amounts.

Maximize Monthly Gross Profits

Minimize Lease Costs

  • Negotiate new rates with leasing companies.
  • Take advantage of prepayment.
  • Take advantage of discounted rates for longer-term leases.

Reduce Total Monthly Loan Repayment Amounts

  • Refinance existing small business debt to reduce monthly amounts repayable.
  • Increase the duration of small business loans to lower monthly repayments, although this will result in you repaying more in interest.
  • Pay off loans as soon as possible.

Understanding your DTI ratio and getting it in order will help to maximize your chances of being accepted for a small business loan. Good luck!