What Is a Good Debt-to-Income Ratio for a Small Business?

Debt-to-Income Ratio for Small Business; Maintaining a lower debt-to-income (DTI) ratio is beneficial for ensuring your business can obtain financing with lower interest rates. Learn more about DTI.

Kelly Boyer SagertUpdated June 28, 2021

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Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.

When small businesses apply for loans, lenders typically have certain guidelines that they’ll use to determine which loans to approve for which borrowers. That includes in what amounts and at what rates. Some of the language that lenders use in their decision-making processes may be unfamiliar to many people. And one of those terms is debt-to-income ratio. So, what is “debt ratio,” exactly? And what is a good debt-to-income ratio for small businesses?This ratio provides a quick snapshot of a business’s debt in relation to its income. Although each lender can have its own debt-to-income requirements, a lower percentage is generally considered more desirable than a higher one. Businesses with lower debt-to-income ratios may get approvals at better rates and terms. Here’s more about how debt-to-income ratio is calculated and what’s considered a good ratio.

Calculating Debt-to-Income Ratios

The calculation is one of the more straightforward financial ratios. Simply divide the sum of your business’s monthly debt payments by its monthly gross income, and the resulting percentage is the debt-to-income ratio. (If you want to express it as a percentage, you can multiply it by 100.) Put more mathematically, the calculation for debt-to-income ratio is:(Total monthly debt / Gross monthly income) X 100 = Debt-to-income ratioLike any other ratio, this one is only as good as the quality of the data in the calculation. If you’re calculating it to see whether it falls within a lender’s guidelines, it’s important to be clear about whether the lender wants this figure to include only business debts and income or business and personal debts/income, too, since that can make quite a difference in the number. When you’re totaling up monthly debt payments for this ratio, typically you’ll include mortgages, vehicle loan payments, minimum amounts due on credit cards, installment loans, and so forth. This figure would typically not include things like utility bills. For the monthly income figure, be sure to use gross income (before taxes and other deductions are taken out).

Debt-to-Income Ratio Calculation Examples

Here are a few sample calculations:

Borrower #1: With a monthly income of $7,000 and monthly debts of $1,500, the debt-to-income ratio would be 21.4% (that’s ($1,500 / $7,000) X 100). If the new loan payment added another $300 to the company’s monthly debt, then the ratio would become 25.7% (that’s ($1,800 / $7,000) X 100).
Borrower #2: With a monthly income of $5,000 and monthly debts of $1,500, the debt-to-income ratio would be 30%. If the new loan payment added another $300 to the monthly debt, then the ratio would become 36%.
Borrower #3: With a monthly income of $9,000 and monthly debts of $3,500, the debt-to-income ratio would be 38.8%. If the new loan payment added another $300 to the monthly debt, then the ratio would become 42.2%.

But now that you know how to calculate your debt-to-income ratio, the next question is what do these debt-to-income ratios mean? And what’s a good debt-to-income ratio for a company?

What is a Good Debt-to-Income Ratio for a Small Business?

As we mentioned earlier, each lender can set its own debt-to-income ratio guidelines for lending. That said, many would like to see a ratio of 36% or lower. For a lender having this requirement, borrower #1 in the example discussed in the previous section would comfortably fit within this lender’s debt-to-income ratio parameters. The business in the second example is right on the nose. But the third business’s ratio is higher than the guideline.Some lenders have a higher debt-to-income ceiling. Although this may be a central metric for many of them, it wouldn’t typically be the only guideline that a small business would need to meet to get loan approval. The debt-to-income ratio is often thought of in connection with applying for a loan. But it has additional impact on small businesses, even if a company isn’t currently looking to borrow money.

1. Tighter Cash Flow

When the ratio is high, this suggests that it might be harder for the company to meet debt obligations. If, for example, customers owe this business money but aren’t paying on time, this in turn could make it difficult for the business to meet its obligations, including payroll and payroll taxes.

2. Prone to Late Fees

When cash is tight because of the debt-to-income ratio and company obligations aren’t fulfilled on time, this can trigger late fees. Those only add to the business’s cash flow problem. In contrast, companies with low ratios and good cash flow may well be taking advantage of early pay discounts and benefiting from a lower cost of goods. Plus, when a company pays its vendors promptly, this can strengthen its relationship with these suppliers.

3. Stagnant Business Growth

When a company has higher amounts of debt, the interest portion of its monthly payments can make it challenging to pay down the balances. That, in turn, can lead to even larger amounts of interest owed. This may make it difficult to manage or expand the business.

Lowering Your Business’s Debt-to-Income Ratio

There are plenty of benefits that can stem from a lower debt-to-income ratio. Even beyond helping to fix the three problems listed above, a lower ratio can simplify getting a loan if and when you need it and can help your business to get better terms and interest rates. To try to lower your ratio, first take a close look at your financial reports, all the way down to a granular level. Know how much your business is paying for rent, wages, raw materials, supplies, and more. Then consider the following.

In what areas could money be saved? Talk to vendors to brainstorm ideas.
Are there ways to buy in bulk to reduce costs?
How can your business tweak its purchasing so that extra inventory and supplies don’t sit on the shelves?
What are the interest rates on your business’s loans? Are they good rates?
If your business sells multiple products, which ones are selling the best?
Which ones have the best margins (make the most profit)?
What is the standard margin for the industry?
What combination of price raising and cost lowering can get your margin to the sweet spot? How does this position your business and its pricing against its competitors?

The goal behind contemplating these questions is to free up more cash, which can in turn be used to pay down debt and lower the debt-to-income ratio. Besides finding ways to reduce expenses, increase revenue, and negotiate with vendors, it sometimes makes sense to get a debt consolidation loan. When debt is consolidated at a lower interest rate, cash flow may be easier to manage, since in that case the new loan might involve lower payments and/or a quicker payback time.

Examples of Small Business Financing

If funding seems like something that might help your business, there are many options available. Here are a few to consider, depending on your situation.SBA loans. SBA loans are guaranteed by the Small Business Administration (SBA). They’re offered by approved lenders and typically come with competitive rates with counseling and education services available through the SBA. Small business loan requirements will vary, depending upon the loan program and lender. In general, lenders will examine how a business earns its income; how the company is owned; where it operates; what other loans have been made to the business; and the creditworthiness of the applicant.Inventory financing. With inventory financing loans, your business gets a loan to purchase inventory. For the lender, the inventory you’re purchasing with the loan serves as collateral. Typically, the amount of financing is calculated on a percentage of the inventory’s value. To help small businesses cut through the noise to see what type of funding might make sense for their unique situations, there’s Lantern Credit.

The Takeaway

Taking control of your debt-to-income ratio can do a lot to help your business and its chances of getting funding at good rates. At Lantern, you can quickly and easily find the types of business funding that work for you. Simply fill out one application and you’ll be provided with a range of options to compare and contrast.

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About the Author

Kelly Boyer Sagert

Kelly Boyer Sagert is an Emmy Award-nominated writer with decades of professional writing experience. As she was getting her writing career off the ground, she spent several years working at a savings and loan institution, working in the following departments: savings, loans, IRAs, and auditing. She has published thousands of pieces online and in print.

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