Net Debt-to-EBITDA Ratio: Definition, Formula, and Example
What Is the Net Debt-to-EBITDA Ratio?
The net debt-to-EBITDA (earnings before interest depreciation and amortization) ratio is a measurement of leverage, calculated as a company’s interest-bearing liabilities minus cash or cash equivalents, divided by its EBITDA. The net debt-to-EBITDA ratio is a debt ratio that shows how many years it would take for a company to pay back its debt if net debt and EBITDA are held constant. However, if a company has more cash than debt, the ratio can be negative. It is similar to the debt/EBITDA ratiobut net debt subtracts cash and cash equivalents while the standard ratio does not.
The Formula for Net Debt-to-EBITDA Is
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Net Debt to EBITDA = frac{Total Debt – Cash & Equivalents}{EBITDA}Net Debt to EBITDA=EBITDATotal Debt−Cash&Equivalents
Key Takeaways
- The net debt-to-EBITDA ratio is a debt ratio that shows how many years it would take for a company to pay back its debt if net debt and EBITDA are held constant.
- When analysts look at the net debt-to-EBITDA ratio, they want to know how well a company can cover its debts.
- It is similar to the debt/EBITDA ratio, but net debt subtracts cash and cash equivalents while the standard ratio does not.
- If a company has more cash than debt, the ratio can be negative.
What Net Debt-to-EBITDA Can Tell You
The net debt-to-EBITDA ratio is popular with analysts because it takes into account a company’s ability to decrease its debt. Ratios higher than 4 or 5 typically set off alarm bells because this indicates that a company is less likely to be able to handle its debt burden, and thus is less likely to be able to take on the additional debt required to grow the business.
The net debt-to-EBITDA ratio should be compared with that of a benchmark or the industry average to determine the creditworthiness of a company. Additionally, a horizontal analysis could be conducted to determine whether a company has increased or decreased its debt burden over a specified period. For horizontal analysis, ratios or items in the financial statement are compared with those of previous periods to determine how the company has grown over the specified time frame.
Example of How to Use Net Debt-to-EBITDA
Suppose an investor wishes to conduct horizontal analysis on Company ABC to determine its ability to pay off its debt. For its previous fiscal year, Company ABC’s short-term debt was $6.31 billion, long-term debt was $28.99 billion, and cash holdings were $13.84 billion.
Therefore, Company ABC reported a net debt of $21.46 billion, or $6.31 billion-plus $28.99 billion less $13.84 billion, and an EBITDA of $60.60 billion during the fiscal period. Consequently, Company ABC’s net debt-to-EBITDA ratio is 0.35 or $21.46 billion divided by $60.60 billion.
Now, for the most recent fiscal year, Company ABC had short-term debt of $8.50 billion, long-term debt of $53.46 billion, and $21.12 billion in cash. The company’s net debt increased by 90.31% to $40.84 billion year-over-year. Company ABC reported an EBITDA of $77.89 billion, a 28.53% increase from its EBITDA the previous year.
Therefore, Company ABC had a net debt to EBITDA ratio of 0.52 or $40.84 billion divided by $77.89 billion. Company ABC’s net debt to EBITDA ratio increased by 0.17, or 49.81% year-over-year.
Limitations of Using Net Debt-to-EBITDA
Analysts like the net debt/EBITDA ratio because it is easy to calculate. Debt figures can be found on the balance sheet and EBITDA can be calculated from the income statement. The issue, however, is that it may not provide the most accurate measure of earnings. More than earnings, analysts want to gauge the amount of cash available for debt repayment.
Depreciation and amortization are non-cash expenses that do not really impact cash flows, but interest can be a significant expense for some companies. Banks and investors looking at the current debt/EBITDA ratio to gain insight on how well the company can pay for its debt may want to consider the impact of interest on the debt, even if that debt will be included in new issuance. In this way, net income minus capital expenditures, plus depreciation and amortization may be the better measure of cash available for debt repayment.