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This Debt Capacity Model Template will help you assess the debt capacity based on various credit metrics and current earnings.
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Debt Capacity Model
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What is Debt Capacity?
Debt capacity refers to the total amount of debt a business can incur and repay according to the terms of the debt agreement. A business takes on debt for several reasons, such as boosting production or marketing, expanding capacity, or acquiring new businesses. However, incurring too much debt or taking on the wrong kind can result in damaging consequences.
At the end of the day, lenders wish to seek comfort and confidence in lending their money to businesses that can internally generate enough earnings and cash flow to not only pay the interest, but also the principal balance.
Assessing Debt Capacity
The two main measures to assess a company’s debt capacity are its balance sheet and cash flow measures. By analyzing key metrics from the balance sheet and cash flow statements, investment bankers determine the amount of sustainable debt a company can handle in an M&A transaction.
Some important credit metrics to measure in assessing debt capacity:
Debt-to-equity ratios provide investment bankers with a high-level overview of a company’s capital structure.
2. Cash Flow Metrics
Another set of measures investment bankers use to assess debt capacity is cash flow metrics. These metrics include total debt to EBITDA, which can be broken down further to senior debt-to-EBITDA, cash interest coverage, and EBITDA-Capital Expenditures interest coverage.
3. Total Debt / EBITDA
The Debt-to-EBITDA measure is the most common cash flow metric to evaluate debt capacity. This ratio exhibits a company’s ability to pay off its incurred debt and provides investment bankers with information on the amount of time required to clear all debt, ignoring interest, taxes, depreciation, and amortization.
4. Cash Interest Coverage
The cash interest coverage measure depicts how many times the cash flow generated from business operations can service the interest expense on the debt.
5. EBITDA-CapEx Interest Coverage
By taking the EBITDA, deducting capital expenditures, and examining how many times this metric can cover the interest expense, investment bankers can assess a company’s debt capacity.
Below is a break down of subject weightings in the FMVA® financial analyst program. As you can see there is a heavy focus on financial modeling, finance, Excel, business valuation, budgeting/forecasting, PowerPoint presentations, accounting and business strategy.
A well rounded financial analyst possesses all of the above skills!
Additional Questions & Answers
CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path.
In order to become a great financial analyst, here are some more questions and answers for you to discover:
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