It is a scale used both to measure the company’s health and when seeking financing. It is also applicable to personal finances.
The company’s debt capacity is the maximum debt limit that it can assume without compromising its viability. Generally, the maximum debt capacity is considered to be 35% of the revenues that the corporation is capable of generating.
The debt capacity of a company will measure where the maximum limit at which the company should take on debt is located. It is a scale used to measure the company’s health and when seeking financing. It is also applicable to personal finances.
What is a company’s debt capacity?
A company’s debt capacity corresponds to the debt limit that can be assumed without jeopardizing the company’s finances as a whole. It is generally used when seeking financing since it is one of the criteria used to assess whether or not financing is granted.
How to know the debt capacity?
For calculating the debt capacity, it is necessary to consider the whole of the finances. Personal in the case of an individual calculation, or of the company in the case of calculating the company’s debt limit. This calculation takes into account basic factors such as:
- Financial debt already acquired
We can calculate a basic way by considering that, usually, it is believed that the debt capacity in an economy should not exceed levels between 30% and 40%.
The debt ratio of a company
With the debt ratio, we can know how much of the company’s debt can be faced with the company’s assets. It is to obtain a proportion between the capital we owe suppliers and creditors and the equity to meet those debts.
If the ratio is 100%, the debt ratio would be 1. That is a bad figure because it would mean you have more debt than assets to face the acquired debt.
What should be taken into account in the debt ceiling?
The factors are taken into account when calculating the debt ceiling, in addition to the income as mentioned above and expenses and financial debt, are as follows:
- Equity: this involves entering the value of the equity as a whole, including the passive elements that have not been calculated in the income and expenses set. If these were sold, they would obtain liquidity and be considered revenue.
- Solvency levels: this is a fundamental factor that, although related to income, is calculated over medium and long-term periods depending on the financing limits to which the company aspires.
- Possibility of added guarantees: although the added deposits do not modify the maximum debt limit upwards, they can support financing valuation when the limit is close to the risk zone. These guarantees may come from the company’s assets or other entities.
What is the maximum debt limit?
The maximum limits of indebtedness are not simple to establish since they must consider many factors, some punctual, and their immediate repercussion.
It is usually taken for granted that the limit amount accepted as a zone of indebtedness should not exceed 35% of income. That may exceptionally increase to 40%.
However, this is not a universal rule. There may be specific moments in the life of a company when debt levels may increase even beyond the exceptional. These times are controlled and managed by the company’s finances. Generally, these situations involve large financing movements or acquisitions of other companies, which, once incorporated into the group, will return the finances to a state below the debt limit.
It is, therefore, necessary to distinguish between the snapshot of a given moment of the company’s finances, in which any movement, even exceptional, may be reflected, and the quarterly, monthly, or annual summaries, depending on the type of structure and accounting strategy of the company.
For years I have studied American finance regulations. All the information in this blog is sourced from official or contrasted sources from reliable sites.
Salesforce Certified SALES & SERVICE Cloud Consultant in February 2020, Salesforce Certified Administrator (ADM-201), and Master degree in “Business Analytics & Big Data Strategy” with more than 13 years of experience in IT consulting.