easy · Debt Capital Markets credit-ratings-risk
Why do lenders use 'EBITDA' instead of 'Net Income' for leverage and coverage covenants?
- It provides a better proxy for the cash flow available to service debt by stripping out non-cash charges and tax effects.
- No statute requires this; selecting a covenant metric is purely a commercial drafting choice between the parties.
- It is a strictly GAAP-defined number that external auditors are required to certify, so management cannot adjust the figure.
- It will always exceed the firm's actual operating cash flow, so the leverage ratio it produces understates the true credit risk.
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