Debt capacity
Debt capacity is a company’s ability to make payments on its current debt and its capacity to take on new debt, should the need arise. BDC names the debt-to-equity, debt service coverage and debt-to-total-assets ratios as the calculations that measure it.
In a purchase, ask whose debt capacity the lender is measuring: the business being bought, yours, or both. A BDC article on how banks assess a business says lending ability is dictated first by cash flow. The guide to financing a business acquisition shows how the loan, the buyer’s own money and any seller financing fit together.
How a bank looks at it
BDC gives a rule of thumb that borrowing capacity is guided by net income plus depreciation, less the annual amount of repayments of existing term debt. It also says banks evaluate assets to identify collateral that can be pledged as security. BDC’s glossary lists the debt service coverage ratio among the calculations that measure debt capacity.
What to ask
- Which measures the lender uses to set the limit.
- Whether existing debt stays in place or is repaid at closing.
- Whether the lender counts the seller’s past earnings or your projections.
- How the lender treats a vendor take-back note.
Sources
This definition is checked against primary sources. Links were last confirmed on the dates shown.
- 01Business Development Bank of CanadaGovernmentWhat is a debt-to-equity ratio?
- 02Business Development Bank of CanadaGovernmentHow a bank looks at your business
- 03Business Development Bank of CanadaGovernment3 ratios to monitor your long-term financial health
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