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Formula – Debt Capacity
D/E = C
D – Debt
E – Equity
C – Debt capacity
The debt capacity ratio resulted from the equation is meant to measure the ability of an entity or individual to service debts within a specified period of time.
Sometimes known as the debt service capacity or debt to equity ratio, this can be a key factor when a lender assesses the mortgage application made by a company buying industrial property.
For individuals, the equity variable in the equation would be replaced by either assets or personal income. This would make it similar to the debt ratio.
Because of this, debt capacity is usually used by lenders for credit assessment of entities rather than individuals.
Companies with strong cash flow are known to have debt capacity ratio of more than 1. This means that their leverage is high with debt exceeding equity.
Not only does debt capacity help lenders to underwrite loans, it can also help a company plan their finances better and work out an appropriate operating budget to work within.