Debt is sometimes considered a nasty word for individuals. However, debt is a necessary and even foundational element for today’s successful businesses. Why is debt foundational? First, most businesses don’t generate enough revenue, especially in their early years, to grow without an outside infusion of capital. Thus, access to capital such as bank loans, lines of credit, and other forms of third-party capital enables a company to thrive and grow. Second, borrowing money protects an owner from the risks of his/her total asset exposure. Third, debt shows that others have confidence in your business. Fourth, debt helps a business build credibility and helps it maintain financial discipline. And fifth, the interest on debt is tax-deductible. A key measure used to measure and utilize debt is the debt-to-income ratio. 

What is The Debt-to-Income Ratio 

The debt-to-income ratio is calculated by dividing a company’s monthly debt payments by its total monthly gross income. Total loan payments are calculated for any commercial real estate loans, equipment leases, lines of credit, vehicle loans, and business credit card payments. Total gross sales are calculated by subtracting the cost of materials and labor for producing goods and services, along with any shipping costs from the total sales amount. 

Why is the Debt-to-Income Ratio Important 

The debt-to-income ratio (DTI) is a measure used by creditors and investors to determine the ability of a company to pay its debts. Thus, it has a major impact on the decision of creditors who may consider extending financing to a business. Also, it can influence investors in their decisions about investing in a company. It helps determine the credit risk for an organization, although it is only a part of a thorough credit analysis for a prospective creditor or investor. 

Other impacts that a high DTI ratio will have include the likelihood that a company will have a tighter cash flow, the possibility that the organization may be prone to experience late fees, and the potential for stagnant business growth. 

What is an Ideal Debt-to-Income Ratio for a Small Business 

A small business debt-to-income ratio should be below 50 percent to be considered for a loan. Ideally, to increase the likelihood of being approved for a loan, the debt-to-income ratio should be 36 percent or even less. The lower the ratio, the more likely it is that a loan will be approved. A low DTI is a good indicator that a company has solid finances. 

How to Improve Your Business Debt-to-Income Ratio 

Here are some ways to improve your debt-to-income ratio: 

  1. Pay off your higher-interest debt obligations first and faster. 
  2. Renegotiate any existing lease terms. 
  3. Refinance higher interest rate loans. 
  4. Consolidate debts, thus potentially resulting in lower interest payments. 
  5. Continue to find ways to increase gross income. 

What’s Healthy and Unhealthy Debt 

Debt that is healthier is debt that is cheaper than equity financing, plus government-sponsored debt programs. 

Debt that is unhealthy is debt that is poorly secured so that it can’t be paid back. That includes taking on too much debt or acquiring debt on bad payment terms. Unhealthy debt is debt that can’t be recovered. Loans to clients and employees are often found to be bad debt.  

It is critical to keep good financial records and review your financials with a financial professional each month. Evaluate your debts frequently and look for ways to improve your financial condition. Also, it is wise to seek alternative financing solutions to get the financing that you need on the best terms. 

Get Expert Alternative Financing Assistance 

Contact Multiple Financial Solutions, with offices in Jacksonville, FL, and Houston, TX. We offer a portfolio of alternative funding solutions for companies that can’t get funding from banks including business lines of credit, merchant cash advances, and commercial real estate funding. We focus on businesses that have been active for 2+ years and are looking to grow to the next level. If you are facing a funding deficit, we are ready to help you.