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Can I Afford A Small Business Loan?


The question “can I afford a loan” isn’t often asked by small business owners because they’re typically getting a loan to afford a business expense. However, knowing whether or not you can take on another monthly expense is just as important as figuring out why you need a loan.

Is A Small Business Loan Right For Me?

Just because you can afford a loan, it doesn’t mean you should get one. A loan isn’t free money, so you need to determine if the problem you’re trying to solve needs a lot of upfront capital.

At the same time, a business loan could be out of reach because you aren’t looking at the right lender. Australians can use iSelect's business loans calculator to find the best rates and terms.

With that said, there are plenty of good reasons to get a loan, like:

  • Business expansion

  • Purchasing inventory

  • Buying equipment

  • Covering off-season expenses

  • Building business credit

The best way to figure out if you need a business loan is by making a business plan. If you have an accurate document that examines each stage of your growth, you’ll feel more confident about your decision. Plus, banks are more likely to lend to you if they see you’re prepared.

How do Lenders Assess Loan Affordability?

Small business lenders want to know if you have enough cash flow to afford your monthly payments and if you can make your payments on time. There are several factors that determine these metrics, but your debt-to-income and debt service coverage ratio are the most important.

Calculating Your Debt-To-Income Ratio (DTIR)

Although DTIR is primarily used for personal loans, it may be used if you’re a sole proprietor or a part of a solo LLC. If your lender uses DTIR, know that the loan will affect your credit if the business goes under because the lender has to use your personal credit score for the loan.

DTIR determines if you have enough money to pay your loan each month. If you don’t have enough income to take on this new debt, you won’t be able to take out the loan.

To calculate DTIR, use the following formula:

Total Monthly Debt / Gross Monthly Income = DTIR

You’ll always get a number that starts with 0. Move the decimal point two places to the right to get a percentage. For example, 0.36122 would become 36%.

When it comes to DTIR, the lower, the better. 36% or lower is considered a great DTIR. At the same time, you don’t want your DTIR to exceed 36% after you take out a loan because you’re at high risk of default. Anything higher than 43% will make it difficult for you to take out a loan. 

Calculating Your Debt Service Coverage Ratio (DSCR)

Lenders will use DSCR if your small business is anything other than a sole proprietor or sole-LLC. DSCR measures a business's income against its debt, so the lender will use your business credit to assess your risk. Here are the most common DSCR calculation lenders use:

Net Operating Income / Current Year’s Debt Obligations = DSCR

Your net operating income equals your total revenue minus a year of operating expenses. 

The DSCR calculation should present a whole number and a few numbers after the decimal. For example, a DSCR of 1.45233 means you have 45% more income than you would need to cover your current debts. You’ll want a 1.25 DSCR or higher to pay down your debts.

Before taking out a loan, make sure to calculate your DSCR with the amount you plan to take out. You’ll want your total debt payment to stay as far away as 1.25 DSCR as possible, even if you have 25% more money to work with because you may bite off more than you can chew.

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