Debt Covenants & Credit Metrics Guide
A practical reference for the metrics CovenantScope calculates. Financial covenants are contractual — definitions of Debt, EBITDA, Cash, Fixed Charges, CFADS and other measures can differ materially between agreements. This guide explains the concepts; your credit agreement controls the actual definitions.
What is a financial covenant?
A financial covenant is a contractual test in a loan or credit agreement that the borrower must satisfy, usually tested periodically (often quarterly). Covenants protect lenders by setting measurable boundaries around leverage, coverage and liquidity. Because they are contractual, their definitions come from your specific agreement — not from a universal standard.
Maintenance vs incurrence covenants
A maintenance covenant must be satisfied every test period — a breach can occur even if no new debt is drawn. An incurrence covenant is tested only when a specific action (e.g. drawing debt, paying dividends, acquiring) is taken; if the test would be failed, the action is simply not permitted. CovenantScope models maintenance-style tests on the figures you enter.
Gross leverage
Gross leverage = Gross Debt ÷ Covenant EBITDA. It measures indebtedness relative to earnings, without netting cash. What counts as "Debt" depends on the agreement — it may or may not include all liabilities.
Net leverage
Net leverage = Net Debt ÷ Covenant EBITDA, where Net Debt = Gross Debt − eligible/qualifying cash. Only cash that qualifies under the covenant definition may be deducted — not all balance-sheet cash necessarily qualifies.
Eligible cash
Cash permitted to be deducted from debt under the covenant definition. Agreements often restrict this to unrestricted cash, cash in specific accounts, or cash net of reserves. Check your credit agreement for the exact definition.
Covenant EBITDA
The EBITDA figure used for covenant testing, as defined in the agreement. It may equal reported EBITDA or be adjusted (see Adjusted EBITDA). CovenantScope lets you use reported EBITDA directly or build an adjusted bridge.
Adjusted / covenant EBITDA bridge
Adjusted EBITDA starts from reported EBITDA and applies permitted add-backs (e.g. restructuring costs, exceptional items) and deductions. Add-backs may be capped (e.g. as a percentage of reported EBITDA). No add-back is universally permitted — what is allowed depends entirely on your agreement.
Interest coverage
Interest coverage = Covenant EBITDA ÷ Cash Interest. It measures the cushion of earnings over cash interest. Definitions of cash interest vary (net vs gross, capitalised or not).
DSCR (Debt Service Coverage Ratio)
DSCR = Cash Flow Available for Debt Service (CFADS) ÷ Debt Service, where debt service is cash interest plus scheduled principal. DSCR definitions vary: some agreements start CFADS from EBITDA, others from operating cash flow. CovenantScope offers direct CFADS (preferred) and an indicative CFADS builder.
FCCR (Fixed Charge Coverage Ratio)
FCCR = numerator ÷ fixed charges. Definitions vary substantially — the numerator may be EBITDA or EBITDA minus capex; fixed charges may include interest, lease expense and sometimes principal. Enter the components per your agreement.
Covenant headroom
Headroom is the gap between a ratio and its threshold. For a maximum covenant, headroom = threshold − actual; for a minimum covenant, headroom = actual − threshold. CovenantScope distinguishes ratio headroom from economic headroom (e.g. EBITDA decline to threshold).
Binding / tightest covenant
The covenant that reaches its threshold first — i.e. requires the smallest percentage decline in EBITDA to reach its threshold. Identifying it helps focus on the constraint that breaks first under stress. Covenants that do not move solely with EBITDA — such as FCCR, and DSCR measured against directly entered CFADS — are not ranked this way; their status is still shown separately.
Debt capacity
The additional debt that could be incurred before reaching a threshold. Leverage-based capacity = (threshold × covenant EBITDA) − existing debt. Coverage-based capacity estimates additional interest capacity and, with an incremental rate, an indicative debt amount. The lower capacity is the binding constraint.
Covenant step-downs / step-ups
Some agreements tighten thresholds over time (step-downs) as the loan amortises, or relax them (step-ups) in certain periods. These scheduled changes affect future headroom and should be read directly from your agreement.
Why definitions vary between credit agreements
Definitions of Debt, EBITDA, Cash, Fixed Charges, CFADS and other measures are negotiated and differ materially between agreements, even for similar transactions. Two "net leverage" covenants may use different debt and cash definitions and so produce different numbers from the same facts.
The credit agreement controls
CovenantScope models the assumptions you enter. It does not determine the correct definitions for your agreement. Always refer to the definitions and testing requirements in your finance documents.