The net debt-to-EBITDA (earnings before interest, depreciation, and amortisation) ratio is a measure of leverage computed by dividing a company’s interest-bearing liabilities by its EBITDA. The net debt-to-EBITDA ratio is a debt ratio that indicates how long it would take a company to pay off its debt if net debt and EBITDA were held constant. The ratio might be negative if a corporation has more cash than debt. It is comparable to the debt/EBITDA ratio, except that net debt excludes cash and cash equivalents, whereas the conventional ratio does not.
What the Net Debt-to-EBITDA Ratio Can Tell You
The net debt-to-EBITDA ratio is popular among analysts since it considers a company’s capacity to reduce debt. Higher ratios above 4 or 5 often raise red flags since they signal that a firm is less likely to be able to manage its debt burden and hence less likely to be able to take on the extra debt required to grow the business.
To establish a company’s creditworthiness, the net debt-to-EBITDA ratio should be compared to that of a benchmark or the industry average. A horizontal analysis might also be performed to assess whether a company’s debt burden has increased or decreased over a given time period. Horizontal analysis compares financial statement ratios or items to those from previous periods to evaluate how the company has grown throughout the chosen time range.
Example of Using Net Debt-to-EBITDA
Assume an investor wants to perform a horizontal analysis on Company ABC to determine its ability to repay its debt. Company ABC’s short-term debt was $6.31 billion, long-term debt was $28.99 billion, and cash holdings were $13.84 billion in the previous fiscal year.
As a result, during the fiscal quarter, Company ABC recorded 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. As a result, the net debt-to-EBITDA ratio for Company ABC is 0.35, or $21.46 billion divided by $60.60 billion.
For the most recent fiscal year, Company ABC had $8.50 billion in short-term debt, $53.46 billion in long-term debt, and $21.12 billion in cash. Year on year, the company’s net debt climbed by 90.31% to $40.84 billion. ABC reported an EBITDA of $77.89 billion, a 28.53% rise over the previous year.
As a result, Company ABC’s net debt to EBITDA ratio was 0.52 (40.84 billion divided by $77.89 billion). Year over year, Company ABC’s net debt to EBITDA ratio climbed by 0.17, or 49.81%.
The Drawbacks of Using Net Debt-to-EBITDA
The net debt/EBITDA ratio is popular among analysts since it is simple to compute. The balance sheet contains debt statistics, and the income statement has EBITDA figures. The issue, however, is that it may not provide the most accurate measure of earnings. Analysts are more interested in the amount of cash available for debt payments than in earnings.
Although depreciation and amortisation are non-cash expenses that have little impact on cash flows, interest can be a major expense for some businesses. Banks and investors examining the present debt/EBITDA ratio to determine how effectively a firm can pay its debt may wish to consider the impact of interest on the debt, even if it would be included in fresh issuance. As a result, net income less capital expenditures plus depreciation and amortisation may be a more accurate indication of cash available for debt payments.
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