Learn how equipment financing can affect debt-to-equity covenants in Canada, including IFRS 16, ASPE, lease liabilities, covenant wording, and lender behaviour.
Here is the short answer first: equipment financing can absolutely affect your debt-to-equity covenant, but not always in the way owners expect.
Sometimes the new financing increases the “debt” side directly. Sometimes it changes the reported balance sheet because of accounting rules. Sometimes the covenant definition in your bank agreement excludes certain lease liabilities, and sometimes it does not. That is why two companies can sign similar equipment deals and see very different covenant outcomes.
The most important thing to understand is this: your covenant is not the same thing as your accounting. The accounting framework matters, but the actual loan agreement wording matters more.
BDC defines the debt-to-equity ratio as total liabilities divided by shareholders’ equity. BDC also notes that this ratio measures how much debt a business is carrying compared with what owners have invested. (bdc.ca) If your financing increases liabilities faster than equity, the ratio gets worse. The nuance is figuring out which liabilities count for your specific covenant.
The key point is that your accounting framework changes the starting point before the lender even applies covenant adjustments.
In Canada, publicly accountable enterprises apply IFRS Accounting Standards, while private enterprises can apply ASPE instead. FRAS Canada’s guidance explains that publicly accountable enterprises are required to apply IFRS, while private enterprises can choose Part I or Part II of the Handbook. (frascanada.ca)
That matters because IFRS 16 requires lessees to recognize a right-of-use asset and a lease liability for leases over 12 months, unless the underlying asset is low value. The IFRS Foundation says IFRS 16 introduced a single lessee accounting model and requires recognition of assets and liabilities for those leases. (ifrs.org)
Under ASPE, lease classification still matters much more. FRAS Canada’s ASPE lease resources continue to reference Section 3065, Leases, which is why many private-company files still behave differently from IFRS files when you look at the balance sheet. (frascanada.ca)
That is the first non-obvious truth: the same equipment lease can have a different covenant impact depending on whether the borrower is on IFRS or ASPE.
If you want the accounting-specific companion reads first, use IFRS 16 and equipment leases in Canada, Operating vs capital lease Canadian tax implications, and Capital lease vs operating lease in Canada.
The key point is that most equipment financing increases leverage unless the covenant definition gives you relief.
Here is the basic equation:
Debt-to-equity = total liabilities / shareholders’ equity
If you add a new equipment loan, capital lease obligation, or recognized lease liability, the numerator usually rises first. Equity does not usually jump at closing just because you financed an asset. So the ratio often worsens at inception.
That does not mean the financing was a bad idea. It means you should model the covenant effect before signing.
This is why a pure “lease versus loan” discussion is incomplete. The covenant answer depends on the reporting framework and the lender’s definitions, not just the product label.
For the structure side, see Lease or loan equipment? Quote-by-quote guide, Equipment financing vs bank loan Canada, and Equipment leasing in Canada: 2026 guide.
The key point is that IFRS 16 moved many leases onto the balance sheet, which can make debt-to-equity look worse even if the business economics did not suddenly deteriorate.
The IFRS Foundation says IFRS 16 was designed to improve transparency by having lessees recognize lease-related assets and liabilities. Its project summary also explains that investors had struggled to compare companies that borrowed to buy assets with companies that leased assets without making adjustments. (ifrs.org)
In practical covenant language, that means this:
This is exactly why savvy CFOs and controllers now ask whether the covenant is:
That last question is not accounting trivia. It is the difference between “no covenant issue” and “we accidentally tripped the line.”
The key point is that even if ASPE reporting makes the balance sheet look friendlier, the lender may still adjust the covenant.
Many private Canadian SMEs use ASPE, not IFRS. That can mean an operating lease does not hit the balance sheet the same way it would under IFRS 16. But that does not guarantee covenant safety.
Lenders do not have to use your statements blindly. They can define debt in the agreement however they want. They may include:
BDC’s glossary explains that covenants are clauses in the agreement that require the borrower to do or avoid doing certain things and are often tied to financial performance. BDC also notes that banks may require businesses to maintain certain financial ratios, including debt-to-equity ratios, as part of financing terms. (bdc.ca) (bdc.ca)
That is the second non-obvious truth: ASPE can make the reported ratio look better, but your lender may still underwrite or test the covenant on an adjusted basis.
The key point is that lenders do not obsess over debt-to-equity because they love ratios. They care because the ratio is a shorthand for risk tolerance.
Under the hood, the lender is thinking about:
A new financed asset can help and hurt at the same time.
It can help because the equipment may generate revenue, improve margins, or replace aging machinery. It can hurt because it adds fixed obligations before that operational upside fully shows up.
This is why the underwriting lens matters more than the accounting label. A strong lender or broker will ask:
If your business already has tight leverage, a seemingly modest equipment deal can become the thing that pushes the covenant into uncomfortable territory.
The key point is that “approved” and “safe for covenants” are not the same thing.
Before funding, you may face conditions precedent such as:
After funding, the real issue becomes covenant compliance. BDC notes that smaller loans often have lighter reporting requirements, but loan terms still commonly require financial reporting and other obligations. BDC also defines default to include failing to meet covenants or failing to address covenant problems. (bdc.ca) (bdc.ca)
In real life, lenders often get concerned before a missed payment. They watch for:
That monitoring reality matters because a covenant problem is rarely about one ratio in isolation. It is usually about a pattern.
The key point is that you should review covenant definitions before you approve the financing internally, not after legal sends the papers.
A smart operator asks five specific questions:
That fifth question is the one people miss. Even if you are compliant today, the lender may test you as if the new financing already exists.
This is where an experienced broker or advisor can save real pain. Mehmi’s equipment financing approval process guide is useful because it frames financing as a structured underwriting exercise, not just a quote request.
The key point is that the best covenant fix is often structural, not argumentative.
If the financing threatens your debt-to-equity covenant, the practical options are usually:
For example, sometimes a lease helps cash flow but hurts the ratio under IFRS 16. Sometimes a sale-leaseback improves liquidity and helps covenant pressure if used to retire other debt. Sometimes the right answer is simply to negotiate an exclusion for lease liabilities in the covenant definition.
If you own significant equipment already, Sale-leaseback tax implications in Canada and Mehmi’s refinancing and sale-leaseback solutions are worth reviewing before you assume the only option is “take more debt.”
The key point is that covenant trouble often comes from definitions, not from the financing itself.
A mid-sized Canadian distributor wanted to add warehouse equipment before peak season. Operations were healthy, but the senior banking facility had a debt-to-equity covenant that management had not revisited in over a year.
The company assumed an equipment lease would be safer than a loan because “it is just a lease.”
That assumption was wrong.
The borrower was on IFRS, and the covenant referenced liabilities in a way that would have captured the new lease liability unless the bank agreed otherwise. On a pro forma basis, the deal would have tightened headroom far more than management expected.
The solution was not to kill the purchase. It was to slow down, model the covenant effect, and negotiate the definition before funding. The equipment still got financed. The mistake would have been signing first and discovering the problem afterward.
Equipment financing affects debt-to-equity covenants in three layers:
That is why there is no universal answer to “Will this lease hurt my debt-to-equity ratio?”
For an IFRS borrower, the answer is often yes, unless the covenant excludes lease liabilities.
For an ASPE borrower, the answer is often maybe, because the lender may still adjust the numbers.
The safest approach is simple: model the covenant effect before signing, ask how the lender defines debt, and do not assume the word “lease” means “off-balance-sheet” or “covenant-friendly.”
A calm next step is to have the financing quote reviewed together with your existing covenant language. Mehmi is useful in that lane because it can look at structure, not just approval.
No. It depends on your accounting framework and your covenant wording. Under IFRS 16, many leases create recognized lease liabilities, which can worsen the ratio unless your lender excludes them. (ifrs.org)
No. IFRS and ASPE can produce different balance-sheet outcomes, especially for leases. Publicly accountable enterprises in Canada are required to apply IFRS, while private enterprises can use ASPE instead. (frascanada.ca)
BDC defines debt-to-equity as total liabilities divided by shareholders’ equity. Your lender may use a modified version in the covenant agreement. (bdc.ca)
Yes. BDC defines default to include failing to meet covenants, not just missing payments. (bdc.ca)
Yes. Banks and other lenders often monitor financial reporting, liquidity, covenant compliance, and other warning signs before an actual payment default occurs. (bdc.ca)
Ask how debt is defined, whether lease liabilities are excluded, how often the covenant is tested, whether the lender uses pro forma testing, and whether your current headroom survives the new deal.
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