A business's earnings before interest, taxes, depreciation and amortization, divided by its fixed charges such as debt payments, capital spending and cash taxes.
The OCC’s handbook on asset-based lending defines the ratio as EBITDA divided by fixed charges, and says it measures the capacity of earnings to pay those charges. Fixed charges are generally the sum of capital expenditures, the current portion of long-term debt, interest and cash taxes, and can include other fixed expenses and required distributions.
Example: a company has EBITDA of $900,000. Its fixed charges are $250,000 of interest, $300,000 of principal due this year, $100,000 of capital spending and $100,000 of cash taxes, or $750,000. The ratio is 1.20.
It differs from debt service coverage by counting more than loan payments, so it is the stricter test of the two for a business that must keep buying equipment. A borrower mostly meets it as a covenant in a business loan agreement, tested each quarter or year. The OCC handbook says that on asset-based lines the financial covenant, when there is one, typically takes this form, and that the definition can vary by borrower. Read the definition in your own loan agreement before you sign, and model it against a slow year.
How it shows up in the data here
Not in any public file. No filing here carries a business borrower's earnings or the covenant a lender set. Business loan balances on a lender's page show that it holds such loans, not their terms. See business lenders for who holds them, and ask each lender for its exact covenant formula in writing.
Go further
- Business lenders: Banks and credit unions by the business loans they hold.
- DSCR calculator: Debt service coverage, the simpler cousin of this ratio.
- DSCR calculator: Cash flow over debt service. Type the cash flow and the loan terms, see the ratio and the cushion before it falls to 1.00x.
- How bankers evaluate a commercial loan deal: A credit officer asks one question five ways: how will this loan be repaid, and what happens if it is not? Knowing the five tests lets you size a request before you send it.
- Business line of credit package checklist: A line of credit pays for the gap between spending money and collecting it. The lender wants to see that the gap is real, that it closes, and what it can take as collateral while it is open.
Related terms
- EBITDA: Earnings before interest, taxes, depreciation and amortization: a business's operating profit before financing costs, income taxes and non-cash charges.
- Debt service coverage ratio (DSCR): Net operating income, or business cash flow, divided by the loan payments due in a year. It shows how many dollars come in for each dollar of debt service.
- Loan covenant: A promise in a loan agreement that the borrower will do certain things, or will not, for as long as the loan is outstanding, such as keeping a minimum debt service coverage ratio.
- Global cash flow: The combined cash flow of a borrower, its owners and their other businesses, set against all of the debt payments those same parties owe.
- Borrowing base: The most a lender will advance on a line of credit at a given time, set as a percentage of the eligible receivables, inventory or other collateral pledged.
- Line of credit: A commitment from a lender to advance money up to a set limit, which a business can draw, repay and draw again as its cash needs rise and fall.
- Term loan: A business loan for a set amount with a maturity of more than one year, repaid on a fixed schedule from the company's cash flow.
Sources
Plain definitions for orientation, not legal, tax or credit advice. A lender's own policy decides what it will do.