Debt capacity is the total amount of debt a business can take on and repay based on the terms of the debt agreement. While taking on debt can help to boost marketing on products, expanding capacity, or acquiring new businesses, it can also lead to high leverage and financial risks for the business.
Lenders can build a debt capacity model to help them assess the amount of leverage a company is able to handle. They can look at the EBITDA of a company because it tells lenders how much-retained earnings can be generated to repay the company's debts. Moreover, credit metrics are usually calculated to determine debt capacity. Some of the common credit metrics are:
- Debt / Equity Ratio
- Total Debt / EBITDA Ratio
- Cash Interest Coverage Ratio
- EBITDA / CapEx Interest Coverage Ratio
- Fixed Charge Coverage Ratio