Debt/EBITDA Ratio

Debt-to-EBITDA Ratio: Definition and Significance

The debt-to-EBITDA ratio measures how many years it would take a company to pay off its debt using earnings before interest, taxes, depreciation, and amortization (EBITDA). It’s widely used by investors, lenders, and analysts to gauge leverage, financial risk, and the company’s ability to service debt from operating earnings.

Formula and Calculation

Debt-to-EBITDA = Total Debt / EBITDA

• Total Debt = short-term debt + long-term debt (from the balance sheet).
• EBITDA = Net income + Interest + Taxes + Depreciation + Amortization (from the income statement).

Note: EBITDA is a non-GAAP metric. Companies may calculate it differently, so confirm what adjustments were made.

Net debt-to-EBITDA is a common variant that uses net debt (total debt minus cash and equivalents), which can give a clearer picture of leverage after accounting for available cash.

What the Ratio Reveals

• Leverage level: Higher ratios indicate heavier debt relative to operating earnings.
• Debt-servicing capacity: Suggests how many years of EBITDA are needed to cover outstanding debt.
• Trend analysis: A falling ratio generally signals improving financial strength (debt reduction and/or rising EBITDA); a rising ratio signals increasing leverage or weaker earnings.
• Comparability: Removes some effects of different financing and non-cash charges, making cross-company comparisons easier—when done within the same industry.

Limitations and Caveats

• Excludes interest costs: EBITDA ignores interest expense, yet interest payments affect cash available to repay debt.
• Non-GAAP variability: EBITDA adjustments differ across companies and can be used to mask poor operating performance.
• Ignores cash flow timing and one-off items: EBITDA isn’t the same as free cash flow; it doesn’t reflect capital expenditures, working capital needs, or irregular gains/losses.
• Industry differences: Capital-intensive industries typically tolerate higher ratios; benchmarking should be industry-specific.
• Debt composition and maturity: The ratio doesn’t account for covenants, interest rates, refinancing risk, or upcoming maturities.

How to Use It Effectively

• Compare companies within the same industry.
• Use alongside:
• Interest coverage ratios (e.g., EBIT/interest expense)
• Net debt-to-EBITDA
• Free cash flow and operating cash flow metrics
• Debt maturity profile and covenant analysis
• Adjust EBITDA for non-recurring items where appropriate to get a truer earnings picture.

Example

Company A:
– Total debt = $100 million
– EBITDA = $10 million
Debt-to-EBITDA = 100 / 10 = 10

If Company A repays 50% of its debt (debt = $50 million) and EBITDA grows to $25 million:
Debt-to-EBITDA = 50 / 25 = 2

What Is a “Good” Debt-to-EBITDA?

There is no universal cutoff—acceptable levels vary by industry and business model. Common informal guidelines:
– Under ~3: generally considered moderate or lower leverage for many industries
– 3–5: moderate to elevated leverage (context- and industry-dependent)
– Over ~5+: typically indicates high leverage and higher credit risk

Always interpret the ratio alongside industry norms and the company’s cash flow profile.

Bottom Line

Debt-to-EBITDA is a quick, useful gauge of leverage and a company’s ability to repay debt from operating earnings. It is most effective when used with other financial metrics and interpreted in the context of industry norms, debt structure, and quality of reported EBITDA.