Debt capacity is two calculations, a multiple of EBITDA and a multiple of cash, and the answer is whichever is lower on the number the lender believes.
A company's debt capacity is the lower of two limits: the leverage multiple times EBITDA, and the debt whose interest and amortisation the cash flow covers at the required ratio. Both must be computed on the lender's adjusted EBITDA, not management's. On an illustrative borrower with 28,460,000 of lender EBITDA, a 4.25x leverage limit allows 120,955,000 and a 1.20x cover test allows 124,731,183, so capacity is 120,955,000: only 955,000 above the 120,000,000 already borrowed.
Worked in full in Credit Analysis by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Most debt capacity calculations stop at the first limit, a multiple of EBITDA, because that is how loans are marketed. The second limit is the one that pays the lender back, and the definition of EBITDA decides which of the two binds. The case below is the borrower worked through Credit Analysis: a packaging business with one set of accounts and four defensible EBITDAs.
| Input | Value |
|---|---|
| Revenue | 285,000,000 |
| Statutory (audited) EBITDA | 24,600,000 |
| EBITDA as adjusted by management | 37,600,000 |
| EBITDA as adjusted by the lender | 28,460,000 |
| Maintenance capex, working capital increase, cash tax | 9,900,000 |
| Cash available for debt service | 18,560,000 |
| Interest rate, all-in | 7.4% |
| Amortisation, a year | 5.0% |
| Leverage limit / cover limit | 4.25x / 1.20x |
| Senior net debt in place | 120,000,000 |
Leverage limit = maximum multiple × lender EBITDA
Cover limit = cash available for debt service ÷ (minimum cover × (interest rate + amortisation rate))
Debt capacity = the lower of the two
In Excel: =MIN(4.25*EBITDA_lender, CADS/(1.2*(Rate+Amort))). The cover limit rearranges the cover test itself: cash ÷ (debt × debt service rate) = 1.20, solved for debt.
Step 1, leverage. 4.25 times 28,460,000 is 120,955,000.
Step 2, cash available. Lender EBITDA less 6,200,000 of maintenance capex, 1,600,000 of working capital and 2,100,000 of cash tax leaves 18,560,000. This is the cash that services the debt; EBITDA is not.
Step 3, cover. Each unit of debt costs 7.4 per cent in interest and 5.0 per cent in amortisation, 12.4 per cent a year. At a required cover of 1.20x, the cash supports 18,560,000 ÷ (1.20 × 12.4 per cent) = 124,731,183, which is 4.38x lender EBITDA.
Step 4, the lower. Leverage binds at 120,955,000. The borrower's 120,000,000 sits at 4.2164x against the 4.25x limit: 955,000 of capacity left, 0.80 per cent. On the cover side the same debt costs 14,880,000 a year to service and is covered 1.2473x.
| Measured on | EBITDA | Leverage on 120,000,000 | Capacity at 4.25x |
|---|---|---|---|
| Management | 37,600,000 | 3.1915x | 159,800,000 |
| Lender | 28,460,000 | 4.2164x | 120,955,000 |
| Statutory | 24,600,000 | 4.8780x | 104,550,000 |
| Cash available for debt service | 18,560,000 | 6.4655x |
Run the leverage limit on management's number and the borrower appears able to carry 159,800,000: 38,845,000 more than the lender's figure supports. That debt would cost 19,815,200 a year to service against 18,560,000 of cash, a cover of 0.94x. The capacity exists only on paper, and the cover limit is what reveals it. On the audited EBITDA the existing loan is already 15,450,000 over capacity, which is why no lender sizes on it either.
The definition of EBITDA moves capacity by more than any rate or covenant assumption in this article. Price each add-back in turns before arguing about the multiple: what an add-back bridge is actually worth does that for the same borrower.
| Interest rate | No amortisation | 5% amortisation | 10% amortisation | Binding capacity |
|---|---|---|---|---|
| 6.4% | 241.7 | 135.7 | 94.3 | 121.0 |
| 7.4% | 209.0 | 124.7 | 88.9 | 121.0 |
| 8.4% | 184.1 | 115.4 | 84.1 | 115.4 |
| 9.4% | 164.5 | 107.4 | 79.7 | 107.4 |
The leverage limit does not care about rates; the cover limit falls as they rise. Here the binding constraint switches from leverage to cover at a rate of 7.79 per cent. At the debt already drawn, the cover test breaks at 7.8889 per cent, only 48.9 basis points above the current rate, so a borrower that looks comfortably inside its leverage covenant is one rate rise from a cover problem. Amortisation matters even more: a 10 per cent schedule takes the cover limit below the debt in place at every rate in the table.
Relaxing the leverage covenant to 5.25x lifts that limit to 149,415,000, but capacity rises only to 124,731,183, because cover takes over. Negotiating a looser multiple buys nothing once the other test is within reach.
Capacity is also a monitoring tool, not just a sizing one. Recompute both limits every quarter on the latest twelve months: when the binding limit falls below the debt drawn, the borrower is over-levered whatever the covenant certificate says.
Compute both limits, on the lender's EBITDA and on cash, and take the lower: 120,955,000 here, with 955,000 of room. Then ask which limit binds and how far each input must move to switch it. The worked case, the four EBITDAs and both covenant tests are in the free workbooks for this case; for the headroom side of the same question, see how to calculate covenant headroom.
It depends on the sector and the definition of EBITDA, which is why the multiple alone means little. On an illustrative borrower, the same 120,000,000 of debt is 3.1915x management's EBITDA, 4.2164x the lender's, 4.8780x the audited figure and 6.4655x cash available for debt service. Quote the multiple with the EBITDA it is measured on.
Because the cover limit divides cash flow by the cost of servicing each unit of debt. With 18,560,000 of cash available, a 1.20x test and 5 per cent amortisation, capacity under cover is 124,731,183 at a 7.4 per cent rate and 107,407,407 at 9.4 per cent. The leverage limit does not move with rates; the cover limit does.
Yes, if the facility amortises, because the borrower must pay it in cash. Testing interest only, an illustrative borrower with 18,560,000 of cash available and a 1.20x test appears to support 209,009,009 of debt at 7.4 per cent, 7.34x EBITDA. Adding 5 per cent amortisation cuts that to 124,731,183.
This article is one calculation from Credit Analysis. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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