What is the debt / EBITDA ratio (debt / EBITDA)?
Debt / EBITDA is a ratio measuring the amount of income generated and available to repay the debt before covering interest, taxes, depreciation and amortization. Debt / EBITDA measures a company’s ability to repay its contracted debt. A high ratio result could indicate that a company has too much debt.
Banks often include a certain debt / EBITDA target in covenants for business loans, and a business must maintain this agreed level or risk making the entire loan immediately due. This measure is commonly used by credit rating agencies to assess the probability of a company defaulting on issued debt, and companies with a high debt / EBITDA ratio may not be able to repay their debt in a appropriate, which results in a downgrade of the credit rating.
Formula and calculation of the debt / EBITDA ratio (debt / EBITDA)
Debt on EBITDA=EBITDADebtTheThe
Debt = Long-term and short-term debt securities
EBITDA = Profit before interest, taxes, depreciation and amortization
To determine the debt / EBITDA ratio, add the company’s long-term and short-term debt securities. You can find these figures in the company’s quarterly and annual financial statements. Divide that by the company’s EBITDA. You can calculate EBITDA using data from the company’s income statement. The standard method of calculating EBITDA is to start with operating profit, also called profit before interest and taxes (EBIT), and then add depreciation and amortization.
The debt / EBITDA ratio is similar to the net debt / EBITDA ratio. The main difference is that the net debt / EBITDA ratio subtracts cash and cash equivalents, unlike the standard ratio.
What the debt / EBITDA (debt / EBITDA) ratio can tell you
The debt / EBITDA ratio compares the total obligations of a business, including debt and other liabilities, to the actual cash that the company contributes and reveals the ability of the business to pay its debt and other liabilities.
When lenders and analysts look at a company’s debt-to-EBITDA ratio, they want to know how well the company can cover its debts. EBITDA represents the profit or income of a business, and is an acronym for profit before interest, taxes, depreciation and amortization. It is calculated by adding interest, taxes, depreciation and amortization to net income.
Analysts often view EBITDA as a more accurate measure of profit from the business of the business, rather than net profit. Some analysts view interest, taxes, depreciation and amortization as a barrier to real cash flow. In other words, they see EBITDA as a sharper representation of the actual free cash flow available to pay down debt.
Key points to remember
- The debt / EBITDA ratio is used by lenders, valuation analysts and investors to assess the liquidity and financial condition of a business.
- The ratio indicates the actual cash flows available to the company to cover its debt and other liabilities.
- A debt to EBITDA ratio that decreases over time indicates a company that is paying down debt or increasing profits, or both.
Example of using the debt / EBITDA ratio (debt / EBITDA)
For example, if Company A has $ 100 million in debt and $ 10 million in EBITDA, the debt / EBITDA ratio is 10. If Company A repays 50% of this debt over the next five years, while increasing EBITDA to $ 25 million, the debt / EBITDA ratio drops to two.
A declining debt / EBITDA ratio is preferable to an increase since it implies that the company repays its debt and / or increases its profits. Likewise, a growing debt / EBITDA ratio means that society increases debt more than profits.
Some industries are more capital intensive than others, so the debt / EBITDA ratio of a company should only be compared to the same ratio for other companies in the same sector. In some sectors, a debt / EBITDA ratio of 10 might be perfectly normal, while in other sectors, a ratio of three to four is more appropriate.
Debt / EBITDA ratio limits (debt / EBITDA)
Analysts appreciate the debt / EBITDA ratio because it is easy to calculate. The debt appears on the balance sheet and the EBITDA can be calculated from the income statement. The problem, however, is that it may not provide the most accurate measure of earnings. More than profits, analysts want to assess the actual amount of cash available for debt repayment.
Depreciation and amortization are non-monetary expenses that do not really affect cash flow, but interest on debt can be a significant expense for some companies. Banks and investors looking at the current debt-to-EBITDA ratio to better understand the extent to which the company can repay its debt may consider the impact of interest on the ability to repay the debt, even if that debt will be included in a new program. For this reason, net income minus capital expenditures, plus amortization and depreciation may be the best measure of the cash available for debt repayment.