Credit Metrics From Financial Statements
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I am a junior analyst in India at a Big 4 advisory firm and I am interviewing for a cross-border leveraged finance role in London. I want a technical grilling that starts from a company’s financial statements and moves into credit metrics. Can you run me through it like a real interviewer would?
Absolutely. Let us start from the balance sheet and cash flow statement, then pressure test the credit story.
First question: if you are given a company with total debt on the balance sheet and a cash flow statement, how would you build a net debt view for leveraged finance purposes? I would want you to talk through gross debt, cash and cash equivalents, restricted cash, lease liabilities, and any debt-like items that may need adjustment. Then explain which items you would include or exclude and why.
I would start with gross debt from short term and long term borrowings, then subtract unrestricted cash and cash equivalents to get net debt. I would not always deduct restricted cash unless it is truly available to service debt. I would also look for debt-like items such as lease liabilities, pension deficits, or factoring arrangements depending on the documentation. If the role is leveraged finance, I should probably normalise these items because headline debt may understate economic leverage.
Good. Now go one step deeper. Suppose the company has EBITDA of 100, reported net debt of 300, and lease liabilities of 20 that should be included. What leverage ratio would you present, and how would you explain the adjustment in an interview? Then tell me what could go wrong if EBITDA is taken straight from the financial statements without normalisation.
If lease liabilities are included, adjusted net debt becomes 320 and leverage is 3.2 times. I would say it is adjusted leverage because lenders often include lease obligations in debt. The risk with using reported EBITDA directly is that it may include one off gains, non recurring income, or expense savings that are not sustainable. I should adjust EBITDA for exceptional items, cost synergies only if they are credible and documented, and maybe run rate changes after acquisitions or disposals.
That is the right direction. Now I want a cash flow bridge. Starting from EBITDA, walk me through the main adjustments to get to operating cash flow and then to free cash flow available for debt service. Be specific about working capital, taxes, interest, capex, and any non cash items. I would also challenge you on why cash flow matters more than accounting profit in a leveraged structure.
From EBITDA, I would deduct cash taxes, cash interest, and changes in working capital, then adjust for non cash items such as depreciation, amortisation, and provisions depending on where I start in the bridge. To get free cash flow available for debt service, I would then subtract maintenance capex, maybe growth capex if I am being conservative, and any mandatory amortisation. Cash flow matters because debt is repaid from cash, not accounting earnings, so a business with strong EBITDA but weak working capital or heavy capex can still be highly stressed.
Exactly. Final round: suppose the company has a 2.5 times debt to EBITDA covenant and a large seasonal working capital build in Q2. How would you assess covenant headroom and explain the risk to a London leveraged finance team? I want you to talk about seasonality, covenant definitions, add backs, and whether the business should be viewed on a reported or a peak debt basis.