Definition
Debt capacity is the amount of debt a business can support while maintaining acceptable coverage ratios and covenant buffers.
Formula
Debt capacity ~= sustainable cash flow / target coverage ratio
Example
If sustainable cash flow is $1M and target coverage is 2.5x, debt capacity is about $400k of annual debt service.
How to use it
- Use conservative cash flow and stress-tested coverage thresholds.
- Recalculate capacity after major growth or margin shifts.
Common mistakes
- Using peak cash flow instead of normalized cash flow.
- Ignoring covenant headroom and refinancing risk.
Measured as
Debt capacity ~= sustainable cash flow / target coverage ratio
Misused when
- Using peak cash flow instead of normalized cash flow.
- Ignoring covenant headroom and refinancing risk.
Operator takeaway
- Use conservative cash flow and stress-tested coverage thresholds.
- Recalculate capacity after major growth or margin shifts.
- Tie Debt Capacity to the same balance-sheet date, scenario, and decision memo you are using elsewhere in the model.
- Document which claims, costs, or adjustments your team includes before comparing numbers across forecasts, covenants, or valuation work.
Next decision
- Read Loan amortization: how monthly payments and total interest work if the decision depends on interpretation, policy, or trade-offs beyond the raw formula.
- Decide whether Debt Capacity belongs in cash planning, valuation, or debt monitoring so the number is used in the right model.
Where to use this on MetricKit
Guides
- Loan amortization: how monthly payments and total interest work: A practical guide to loan amortization: monthly payment formula, why interest dominates early, and how term and rate affect total interest.
- Runway and burn: gross vs net burn, working capital, and cash levers: A practical guide to runway: compute net burn, understand why cash differs from profit, and how working capital and collections change runway.