Debt Limitation

  

A clause in a bond covenant that limits the amount of overall debt the organization issuing the bond can take on.

See: Debt/EBITDA.

Cash flow. That's what a company needs in order to pay its interest on the debt it has incurred. Cash. Green stuff. Bank. A given company has $30 million in earnings and $35 million in cash profits. They're depreciating that factory they bought 4 years ago for another 11 years. They have $500 million in debt, which carries 5% interest, or $25 million just to pay the interest on that debt. They then have to add another $15 million a year to pay down principal. They are at their absolute max limit for the debt they can take on. One tiny hiccup and the company is bankrupt.

Related or Semi-related Video

Finance: What is Debt?62 Views

00:00

finance a la shmoop.. what is debt..well debt happens anytime you or anyone else

00:13

or anything else borrows money and promises to pay it back countries borrow [Hands out looking to borrow cash]

00:18

money from their citizens and from other countries

00:21

Granny borrows money from the equity in her house to pay for her full body skin [Granny getting a full body skin procedure]

00:27

lift procedure, ew! you'll probably borrow money to go to college buy a car

00:32

and buy a home credit cards are golden or plastic

00:35

tickets that let you easily borrow relatively small amounts of money to you

00:40

know buy stuff so there are tons of types of debt and to really understand [lots of examples of debt]

00:44

it all you have to think about debt from both sides of the equation that is you

00:49

as the borrower want the most flexible payback terms the cheapest interest

00:54

rates to rent that money and the least amount of grief if you're ever late on a

00:58

payment but what if you're the lender well you only have so much money to lend [woman walking and approaches a vault of cash]

01:03

and you want to maximize your returns while being smart about risk that is if

01:07

you loan 10 grand to 10 people and 9 of them pay you a fat 10% a year but one of [woman at a stand giving loans to people]

01:12

them absconds with your money to Brazil with senorita maracas well then

01:17

all your work was for nothing more or less when the interest just paid back

01:21

the lost principal on the one who absconded and yeah one bad loan can wipe

01:26

out the returns of your entire portfolio your billion bucks was supposed to produce [Man falls in water while surfboarding]

01:30

a hundred million in interest gains but when one of the ten hundred million

01:34

dollar investments died and well you ended up sitting on a billion and that's

01:39

it so no jet for you so would you loan money to your slacker friend Flaky McGee [Flaky McGee and Bill Gates together]

01:45

for the same rent as you lend to Bill Gates while Flaky McGee has a history of

01:50

you know flaking hence the name. so you'd have to take the risk of him [Flaky McGee in the kitchen with his Mom]

01:54

not paying you and you'd have to track him down in Rio or get lawyers to take

01:58

possession of the skateboard collateral he pledged for the loan and then sell it [Lawyers taking Flaky McGee's skateboard as collateral]

02:02

on eBay and hopefully get most of your money back

02:05

we'll go on record saying that you'll likely charge Flaky McGee a lot more in

02:09

interest and make the terms and conditions much more brutal than you [Terms and conditions for Flaky's loan]

02:13

would for dear old Bill well one big thing people don't seem to understand is

02:17

that debt is just about someone renting money debt does not involve ownership of

02:24

anything other than the promissory paper that contractually outlines the debt

02:28

terms the only time debt does involve ownership is when the piece of paper has [Flaky sat on a toilet]

02:32

been well you know made into toilet paper because the debtor flaked and

02:36

didn't pay back the loan that they promised to pay at that point the one

02:40

who loaned the money usually has every right to take back the collateral [Man drives car away from Flaky]

02:44

pledged behind the debt and if that collateral can't be found to break knees

02:49

you know the guys with the baseball bat remember? you ever see The Sopranos well so [Flaky screaming while on the toilet]

02:55

if you ever find yourself in that position make sure to you know hide your

02:59

knees

Up Next

Finance: What is a debt covenant?
4 Views

What is a debt covenant? Covenants are added clauses to a loan agreement that are dictated by the lender that the borrower has to agree to in order...

Find other enlightening terms in Shmoop Finance Genius Bar(f)