Debt Capacity

Debt capacity is the maximum debt burden that a company can sustainably carry and service. It mainly depends on how stable and high future cash flows are. If it is exceeded, the risk increases that interest and repayments can no longer be paid.

In practice it is determined through several metrics at once: a multiple of adjusted EBITDA, interest cover, and debt service cover, which looks at interest and amortisation together. The leverage banks accept relative to EBITDA depends on sector, earnings stability and market conditions, while cyclical businesses, project-driven models or companies with high customer concentration stay well below that and contractually secured recurring revenue supports more. Beyond earnings, further factors matter. Capital expenditure needs reduce capacity, because cash for replacement investment is not available for debt service. Working capital volatility and the availability of valuable collateral also play a role, as do conditions in the bank and credit fund markets, which change independently of the company. The distinction from actual leverage matters: capacity describes the ceiling, not the current position, and the gap between the two is the room for acquisitions, investment or a distribution. In a leveraged buyout this figure is the starting point of the entire structure, because together with available equity it determines the affordable purchase price.

In a specific case not a single figure but a corridor is determined, resulting from several constraints at once: a multiple of earnings, a minimum interest cover, a minimum debt service cover and a ceiling on the value of security. The strictest of these binds, so a company with good earnings but weak collateral can still be limited in what it can borrow. The calculation is presented in a base case and a downside scenario.