What Is the Net Debt-to-EBITDA Ratio?
You need to understand that the net debt-to-EBITDA ratio is a straightforward measure of leverage. I calculate it by taking a company's interest-bearing liabilities, subtracting cash or cash equivalents, and then dividing by its EBITDA. EBITDA means earnings before interest, taxes, depreciation, and amortization. This ratio tells you, in years, how long it would take the company to pay back its debt if all earnings went solely to repayment. If a company has more cash than debt, you'll see a negative ratio, which is actually a good thing. It's like the debt/EBITDA ratio, but this one nets out cash and equivalents, unlike the standard version.
Key Takeaways
- When I look at the net debt-to-EBITDA ratio, I'm checking how well a company can cover its debts.
- It's 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, a positive sign for meeting its debt obligations.
- A ratio of 1 to 3 can indicate debt manageability, while a ratio higher than 3 may mean trouble.
The Formula for Net Debt-to-EBITDA
Here's the formula you use: Net Debt to EBITDA = (Total Debt - Cash & Equivalents) / EBITDA. This gives you a clear picture of the company's risk exposure and financial health.
What Net Debt-to-EBITDA Can Tell You
I find the net debt-to-EBITDA ratio popular among analysts because it shows a company's ability to reduce its debt. A ratio less than 1, or even negative, means the company has more cash than debt and can likely pay it off easily. Ratios from 1 to 3 generally show the company can handle its payments. But if it's higher than 3, that raises concerns—the company might struggle with its debt load and be less able to take on more debt for growth.
Industry Comparisons
You should compare the net debt-to-EBITDA ratio to a benchmark or industry average to gauge a company's risk and creditworthiness. Some industries, like telecom and utilities, are capital-intensive and naturally have higher ratios, but that's not always a problem since they often have stable income to manage the debt. You can also do a horizontal analysis to see if the company's debt burden has increased or decreased over time. In horizontal analysis, you compare ratios or financial items from previous periods to track growth over that timeframe.
Example of How to Use Net Debt-to-EBITDA
Let's say you're analyzing Company ABC with horizontal analysis to check its debt repayment ability. For the previous fiscal year, short-term debt was $6.31 billion, long-term debt $28.99 billion, and cash $13.84 billion. Net debt comes to $21.46 billion, and EBITDA was $60.60 billion, giving a ratio of 0.35. That's a sign of good financial health. Now, in the recent year, short-term debt is $8.50 billion, long-term $53.46 billion, cash $21.12 billion. Net debt rises to $40.84 billion, EBITDA to $77.89 billion, for a ratio of 0.52. The ratio increased by 0.17 year-over-year, but still under 1, so the company can confidently meet obligations despite faster debt growth than income.
Limitations of Using Net Debt-to-EBITDA
Analysts like this ratio because it's easy to calculate—debt from the balance sheet, EBITDA from the income statement. But it might not give the most accurate earnings measure. What you really want is the cash available for repayment. Depreciation and amortization are non-cash, so they don't affect cash flows much, but interest can be a big expense. If you're a bank or investor, consider interest's impact on debt. Sometimes, net income minus capital expenditures, plus depreciation and amortization, is a better gauge of cash for debt repayment.
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