Definition of Debt / EBITDA?

Debt / EBITDA is one of the key financial ratios used in assessing the creditworthiness of a corporation both by rating agencies and in debt-financed takeovers. It is also used to determine the ability of a firm to service any debt it holds. EBITDA is used as an approximation of operational cash flow, so it is essentially the ratio of debt to cash flow from the operations of the business.

Debt To EBITDA Ratio

The calculation for Debt / EBITDA is simple:

• Debt / EBITDA

In this instance - total debt is defined as all interest-bearing liabilities. This means that working capital items such as accounts receivable wouldn't be included in this debt metric.

The actual calculation is open to interpretation as preferred shares can count as either debt or equity, and therefore someone working on valuation can manipulate the figures to meet the appropriate multiple requirements.

High values of Debt / EBITDA would indicate an extremely indebted company which may not be able to service its debt, and therefore would have a lower credit rating and have to offer higher yields on bonds. When attempting to determine what a high/low ratio is - it is important to look at the industry average as it will vary a great deal by industry. Generally, a ratio of 4 or 5 is considered to be high.

Debt / EBITDA is frequently included in loan agreements as a covenant saying that the firm must maintain certain debt to EBITDA ratio, or else must pay back the loan.

Net Debt / EBITDA Multiple

Net Debt / EBITDA looks at the (interest-bearing liabilities - cash) / EBITDA. This is a valuable metric to review as it accounts for the fact that the company could lower its debts with the cash on hand at any given time.