The relationship between debt and income of an individual or company is known as the indebtedness index. Basically, it is the percentage of income or revenue that is being used to pay off debts.
Lenders, investors, accountants, administrators, and financial planners use the debt ratio to discover the risks that their finances pose. For example, a bank can use its debt to income ratio to find out how much you can afford on a loan for your business or a personal loan.
You, too, can calculate your debt ratio or your company to find out how much debt you have. There are online calculators that make it easy to calculate, so you only need to enter your income / income information and debts. But it is always good to understand how the calculation is done, to be able to adopt procedures that will help you improve your financial health.
Debt composition: total monthly debts
The ratio of debt to revenue is equal to monthly debt divided by monthly income. For companies, it means the liability divided by the assets of the company.
IE = monthly debt or liabilities / monthly income or assets
To realize this calculation, in monthly debt or liabilities, the following personal or company expenses must be paid:
- Mortgage or rent
- Credit card
- Financing of equipment and / or vehicles
- Student Loans
- Alimony payments
- Other loans
- 3-month average of variable costs, such as production inputs, consumption inputs, grocery shopping, etc.
- Utility bills: water, electricity, gas
- Firm fixed costs with employees
- IPTU and other taxes due
The total amount is the value of your liabilities or your debt.
By calculating your level of indebtedness, it becomes much easier to understand how your finances are and to adopt a strategy to get out of debt and the risks of over-indebtedness.
Income or monthly income
The next step in determining your debt ratio is to calculate your monthly income. Start by adding up the entire person or company revenue in the following ways:
- Gross Revenue
- Bonus or Overtime
- Any type of pension
- Sales income and freelance jobs
- Other income.
Indebtedness index: applied formula
After calculating what you spend every month on debt payments and what you or your company receive monthly in income, you have what you need to calculate your debt-to-income ratio. To calculate the debt ratio, divide your monthly debt by your monthly income. Then multiply the result by 100 to reach a percentage.
What is debt? The utility of the debt ratio
Your bottom line will fall into one of the following categories, which will best describe your financial health or your business
A result of 36% or less is the healthiest debt burden for most people and businesses. Avoid incurring more debt to maintain a good relationship.
A result between 37% and 42% is not a bad position. If your ratio falls on this scale, you should start reducing your debts to improve your financial performance.
A result between 43% and 49% is a proportion that indicates a probable financial problem. Start paying your debts now to avoid an overburdened debt situation, or result in your company’s insolvency or even bankruptcy.
A score of 50% or more is a dangerous proportion. You must adopt an aggressive strategy to repay your debts. Do not hesitate to seek professional help.
The value of the debt ratio is an excellent indicator of your financial health or your business. Do everything to keep your levels healthy, and your business and personal life will be well underway.
How do you deal with debt? What procedures do you follow to maintain a low debt ratio?