Financing & treasury
Debt capacity analysis
A debt capacity analysis tests whether a borrowing entity could realistically service and repay a given level of debt on a standalone basis, using metrics such as interest coverage, leverage ratios, and cash flow projections benchmarked against comparable independent companies operating in the same industry and broader economic.
Where the analysis shows debt exceeding what an unrelated lender would extend, tax authorities may recharacterise the excess as equity, disallowing associated interest deductions entirely, so the analysis is a critical first step before any interest rate benchmarking exercise, since pricing an unsupportable loan achieves little.
Groups should perform this analysis before drawing down significant intercompany debt, not retrospectively during an audit, using realistic financial projections rather than optimistic forecasts, and revisiting the conclusion whenever the borrower's business, market conditions, or overall financial position changes materially.
In practice
What matters when applying debt capacity analysis
- Benchmark leverage and coverage against comparable companies
- Use realistic, not overly optimistic, cash flow projections
- Perform the analysis before, not after, debt is drawn down
- Revisit conclusions as the borrower's position changes
- Link results directly to the interest rate benchmarking exercise
Frequently asked
Common questions
Why perform a debt capacity analysis?+
To confirm the borrower could genuinely service and repay the proposed debt on a standalone basis, avoiding recharacterisation of the debt as equity and the resulting disallowance of interest deductions.
What metrics does it typically use?+
Interest coverage ratios, leverage ratios, and realistic cash flow projections, all benchmarked against comparable independent companies operating in the same industry and economic conditions.
See how the tooling handles this in practice
Our transfer pricing tools calculate intercompany charges, benchmark financing and reconcile the intercompany ledger from your own data. Book a short walkthrough and we will show the workflow on a scenario that matches your group structure, rather than a generic demo dataset.