What is a Debt-to-Income Ratio?
In finance, there are a lot of different mathematical formulas used to calculate how well a company is doing. But the debt-to-income ratio is one of the best of them overall. That is because it is reflective of how likely a company is to be successful at financially staying afloat.
How do You Calculate the Debt-to-Income Ratio?
The debt-to-income ratio is calculated by dividing the total amount of debt by the total amount of income that a company has. The debt figure has to include both long-term and short-term debt amounts. And the income calculation must be the same, especially in regards to any revenue that it expects to achieve.
Who Needs to Use the Debt-to-Income Ratio?
The division of the amount of debt by the amount of income will result in a percentage, which is needed by banks and financial investors. If it is too high, then it will be difficult to get funding. If it is too low, it will show that the company is not attempting to achieve any growth. Overall, a good number to have is less than 48% though.
How Can a Company Lower Their Debt-to-Income Ratio?
A company who has been turned down by banks or investors will have to work at changing their financial statements to reflect that they have been attempting to pay off their debt. They may do this by demanding payment from customers who owe them money, selling assets to increase their cash flow for debt payoffs, or making changes to increase the amount income that they will be getting.
What Happens if a Company Continues to Carry too Much Debt?
If a company doesn’t make the changes that it needs to lower their debt-to-income ratio, there is a good chance that they will lose the few investors or shareholders that they already have. No one wants to stay in a sinking ship. And too much debt means that a company isn’t going to look appealing to any new investors either. Bank loans and lines of credit will also be difficult to get approved for.