How Much Of A Business Loan Can I Get?

There is no standard way to calculate DSCR. Some lump the business owners’ personal income in with the net operating income of the business, while others don’t.

Here is the most common DSCR formula, but make sure to check with your lender about how they calculate DSCR to find your most accurate ratio.

Most often, your business’s DSCR is calculated by dividing your net operating income by your current year’s debt obligations:

Net Operating Income / Current Year’s Debt Obligations = Debt Service Coverage Ratio

Your net operating income is the total revenue generated by selling services or goods, minus your operating expenses (operating expenses are anything that is directly related to purchasing, creating, or selling your goods and products).

Your current year’s debt obligations comprise the total amount of debt you must repay in the next year, including interest payments and fees.

Let’s look at an example:

A business owner wants to know whether or not they can afford a loan to purchase some new equipment. The business takes in $65,000 in revenue annually but pays $15,000 in operating expenses, resulting in a net operating income of $50,000.

Each month, the business spends $2,000 on its mortgage, $400 on a previous loan, and $100 on a business credit card, making a total monthly debt of $2,500. Since the DSCR calculation requires the current year’s debt, we need to multiply our monthly debt by 12. That gives us a total of $30,000 in debt obligations for the year. Now, let’s plug these numbers into the DSCR formula from earlier.

Net Operating Income / Current Year’s Debt Obligations = Debt Service Coverage Ratio

50,000 / 30,000 = Debt Service Coverage Ratio

50,000 / 30,000 = 1.666667

When you divide 50,000 by 30,000 you get 1.666667. Round this number to the nearest hundredth to get a current debt service coverage ratio of 1.67.

The higher your DSCR is, the better. If your DSCR is 1.67 (like our example above), that means you have 67% more income than you need to cover your current debts.

A DSCR ratio of 1 means that you only have exactly enough income to pay your debts and aren’t making any extra profit. If your DCSR is below one, then you have negative cash flow and can only partially cover your debts.

Generally speaking, a good DSCR is 1.25 or higher.

This varies by lender and the health of the economy, but a high DSCR suggests that you have enough income to take on more debt and are more likely to qualify for the loan you want.

Your DSCR will tell you if your small business can afford to take on a loan, and it will also help you determine the size of the loan you can take out.

Using our earlier example, the business’s DSCR is 1.67, which is well above the 1.25 DSCR mark, but this doesn’t tell us the size of the loan this business can afford to borrow.

To figure out the amount the business can safely borrow, we’ll take its annual income and divide it by 1.25:

Net Operating Income / 1.25 = Borrowing Amount

50,000 / 1.25 = 40,000

The business can afford to pay up to $40,000 a year on total debt obligations. In our example, the current year’s debt obligations were already $30,000/year. All in all, the business can take on an extra $10,000/year in debt (because $40,000 – $30,000 = $10,000). That amounts to roughly $830/month.

Use your own information to determine the ideal loan size for your small business. This will help give you an idea of how much you can realistically afford to pay each month before you talk to a lender.

Your DTI ratio acts as an indicator of your trustworthiness for potential lenders.

Credit scores show how likely someone is to make their payment on time, DTI ratio shows whether or not someone can afford the monthly payments on a personal loan or mortgage.

If it’s primarily used for personal loans and mortgages, why does the DTI ratio matter for small businesses?

The DTI ratio is particularly important for sole proprietors and freelancers looking for funding. Sole proprietors won’t have a DSCR because they aren’t legally considered separate business entities. The DTI ratio will be used to analyze a loan application instead.

The DSCR is a much better indicator of the financial state of a small business, but lenders will still look at an owner’s DTI ratio. Lenders want to ensure that you are trustworthy and can personally guarantee your business loan if no other collateral is provided.

It’s important for you to consider if you can personally afford to take on the business loan payments if your business goes under. It isn’t something small business owners want to think about, but it’s a reality you need to consider before taking on a new business loan.

If you can’t afford to offer up collateral or take on a personal guarantee, a business loan isn’t right for you.

To calculate your DTI ratio, divide your total recurring monthly debt by your gross monthly income:

Total Monthly Debt / Gross Monthly Income = DTI Ratio

Your total monthly debt should include all recurring minimum monthly debt payments, while your gross monthly income should include your total monthly income before taxes.

Here’s an example:

You’re trying to use your DTI to see if you qualify for a mortgage. You pay $300/month for your car and $200 on student loans for a total monthly debt of $500. Your monthly gross income is $3,500/month.

500 / 3,500 = DTI Ratio

500 / 3,500 = 0.142857

This gives you a current debt-to-income ratio of 14%.

Add your own financial information into the formula to see what your DTI ratio is.

The lower your DTI ratio is, the better. A low DTI ratio shows that you can afford to take on an additional loan and raises your chances of getting approved for the loan you want. A high DTI ratio means you have too much existing debt or too little income to be able to afford to take on a new loan.

A DTI ratio of 36% or lower is generally considered good. Many lenders will finance up to 43%, but if your DTI is higher than that, you’re going to have a hard time getting approved for a loan.

Both DSCR and DTI percentages will vary, so be sure to research your lender’s requirements.

Your DTI ratio can be used to determine how much you can afford to pay monthly on a new loan.

If you’re a sole proprietor seeking funding, this calculation is going to be crucial. Small businesses should still do this calculation to make sure they can afford to personally cover the payments on a defaulted loan.

In the example from earlier, you were trying to qualify for a mortgage loan. Your DTI ratio was 14%.

In order to maintain a good DTI ratio, you don’t want it to exceed 36%, which means a potential mortgage can take up 22% of your total DTI ratio (36 – 14 = 22).

To determine the size of the mortgage loan payment you can afford each month, multiply your gross monthly income by 22%.

3,500 x .22 = 770

If you want to stick to a 36% DTI, you can afford to pay $770/month on your mortgage while continuing to make your other loan payments and covering regular expenses.

Learn more about how to calculate and lower your DTI.

Increasing your income can open the doors to more business opportunities and additional funding. By increasing revenue, you can improve your DSCR, lower your DTI ratio, and boost your chances of qualifying for a loan.

Another way to increase DSCR and lower DTI is to pay off some existing debt. With old loans out of the way, you can move on and take out new loans to help propel your business forward.

Another way to improve your debt service coverage ratio is to decrease operating expenses. By cutting back on unnecessary expenses and streamlining your business processes, you’ll have a greater overall net operating income, which means more money that you could apply towards a loan.

For borrowers seeking a mortgage, making a bigger down payment is another good way to lower your DTI and decrease the size of your monthly payments.

Another major roadblock businesses and individuals run into when seeking funding is a low credit score. Improving your credit score can help unlock better loans and rates. Need some guidance on improving your credit score? Check out five ways to improve your credit score.

Maybe you really can afford a loan right now and just need to lower your borrowing amount. You may not be able to afford the $100,000 loan you were hoping for, but can you afford the monthly payments on a $50,000 loan?

If you can satisfy your needs with a smaller borrowing amount, you should try to do so. If a smaller amount won’t cut it, use the tips above to improve your financial situation so you can eventually afford the loan you want.