One of the main ways that businesses can get money to fund expansions, equipment purchases and leases, inventory purchases and the payment of unexpected debts is by getting a business loan. However, just as lenders make judgments on the financial stability of individual borrowers before making loans, they look at the financial stability of companies as well. One important factor that they look at is a business's debt to income ratio.
Defining Debt to Income Ratio
The chances are that your business already has various debts, whether they be for loans related to real estate, vehicles or equipment. As your liabilities increase, your ability to pay for additional liabilities decreases. However, lenders do not just look at how much you owe to determine your ability to take on additional loans: they also look at your business's profits. $100,000 of debt could be a heavy burden for a small business, but such a debt would be almost negligible for a large business. To calculate your ability to take on more debt relative to your income, lenders divide your liabilities by your income.
A Safe Debt to Income Ratio
Since your debt to income ratio is not the only thing that lenders look at to judge your ability to take on another loan, and since lenders may use different methods to judge, the maximum ratio varies from lender to lender. In general, though, most lenders consider anything above 40 percent to be high. If your ratio is under 40 percent and you otherwise seem to be financially stable, lenders will usually be willing to give you a loan.
Other Factors in Loan Consideration
Though your business's debt to income ratio is a very important determinant of creditworthiness, some other important determinants do exist. One is your history of debt payment; if your company has made a practice of paying debts on time and in full, you stand a good chance of getting further funding. Another determinant is the length of time your business has had credit. If your business has been making faithful payments but only for a year or less, lenders may not view this as an adequate judgment of your business's creditworthiness.
Effects of a Poor Ratio
The most overt effect of having a poor debt to income ratio is that it makes it difficult for your business to get additional funding, which can retard its ability to expand or remain financially stable during temporary economic downturns. In addition to this, though, having such a poor debt to income ratio can also affect the way in which clients and investors view your business. If your business relies on a small number of high-gross sales or contracts, your clients will be more likely to investigate your business before going forward with you and, if they feel that your business is financially unstable, they may not want to work with you. Similarly, for corporations or businesses that will be incorporating soon, a poor debt to income ratio can cause stock prices to drop.