Skip to content
ruly
Open the app

Net debt to EBITDA: measuring the weight of debt

Definition of the net debt to EBITDA ratio, its formula, where to find debt and EBITDA in an annual report, usual thresholds by profile, the effect of IFRS 16 and traps.

Published

Definition

The net debt to EBITDA ratio divides financial debt, minus cash, by operating profit before depreciation and amortization (EBITDA). It shows how many years the company would need to pay off its debt if it devoted all of its EBITDA to it. The lower it is, the more room the company keeps if its results fall.

Formula

Net debt / EBITDA = (financial debt − cash and cash equivalents) / EBITDA

Where to find it in an annual report

Short and long-term financial debt and cash are on the balance sheet. The note on borrowings often gives net debt ready-made. EBITDA is not a required line of the income statement: it usually appears in the management report, otherwise it is calculated by adding the depreciation and amortization from the cash flow statement to operating profit.

Common thresholds

Long-term quality: 1.5 at most for green, up to 3 for orange. Growing dividend: 2.5 and 3.5. Value: 2 and 3. A negative ratio means cash exceeds debt. Sectors with very stable revenue (networks, concessions) often carry 4 to 5 times EBITDA.

In the preset strategies

Preset strategy Criterion met To monitor Criterion not met
Long-term quality Net debt / EBITDA ≤ 1.5 1.5 to 3 > 3
Growing dividend Net debt / EBITDA ≤ 2.5 2.5 to 3.5 > 3.5
Value Net debt / EBITDA ≤ 2 2 to 3 > 3

Pitfalls

  • Since IFRS 16 (2019), lease commitments count as debt and no longer as expenses: debt and EBITDA both increase. Compare figures calculated the same way, before or after IFRS 16.
  • Year-end cash can be unusually high (December receipts): average net debt over the year is sometimes much higher.
  • EBITDA ignores capital spending: a company that must invest heavily to maintain its assets can repay less than the ratio suggests.
  • Pension obligations and some off-balance-sheet debts are not part of net debt, yet they weigh on the company.

Where it does not apply

  • Banks and insurers: debt is their raw material, so the ratio makes no sense. Regulatory solvency ratios replace it.
  • Real estate companies: debt is usually tracked against the value of the properties (loan to value).

A worked example

A fictitious company, called Company K here, has €600 million of financial debt and €150 million of cash. Its net debt is €450 million. Its EBITDA is €250 million. Its ratio is 450 / 250 = 1.8: orange for Long-term quality, green for Growing dividend and Value.

What the ratio does not say

The ratio says nothing about the maturity of the debt or its interest rate. Debt of 3 times EBITDA at a fixed rate, repayable in ten years, weighs less than debt of 2 times due next year. The note on borrowings gives the repayment schedule. See also the net cash entry.

Sources