Understanding Debt to EBITDA Ratio
The Debt to EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) Ratio is a solvency metric that measures the company's ability to meet its debt obligations by earnings before covering its interest, taxes, depreciation, and amortization. It is calculated by dividing Total Debt by EBITDA. Banks and creditors frequently use the debt to EBITDA ratio before lending money to a company.
The formula to derive Debt to EBITDA Ratio
Total Debt -
It is a sum of the company's long-term debts and short-term debts. And it is found in the company's liabilities section of the Balance Sheet.
EBITDA stands for Earnings before interest, taxes, depreciation, and amortization and is found in the company's Income Statement.
Example of Debt to EBITDA:
For the financial year, Aurobindo Pharma Limited reported total debt as Rs. 5182.99 Cr. and EBITDA as Rs. 8473.47 Cr.
The value as per the formula is calculated as (Total Debt / EBITDA) is calculated as (5182.99 / 8473.47) = 0.61.
The debt to EBITDA ratio measures the company's ability to meet its debt obligations by earnings before covering its interest, taxes, depreciation, and amortization.
The debt to EBITDA ratio is calculated as total debts divided by EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).
Many lenders and analysts used the debt to EBITDA ratio to evaluate the ability of the company to covations.
While looking at the Debt to EBITDA Ratio, the following points should also take into consideration:
The debt to EBITDA ratio below three is acceptable for most industries. A low ratio indicates that the company is financially strong and the EBITDA of the company is higher than its debt, and the company can meet debt obligations.
A high debt to EBITDA ratio indicates that the company is more loaded with debt than its EBITDA. But investors must check the factors behind it and its industry average.
Capital intensive companies may have a high debt to EBITDA ratio relative to
Many lenders and analysts used the debt to EBITDA ratio to evaluate the ability of the company to cover its debt obligations.
In the formula, EBITDA is used instead of net income, as many investors look at EBITDA as a more accurate measure of the company's earnings.
How to use the Debt to EBITDA ratio effectively
Investors should look for a low ratio below three. It indicates that the company is financially healthy and can cover its debt obligations by earnings before interest, taxes, depreciation, and amortization.
While looking at companies with high debt to EBITDA ratio, investors must check other factors behind it. A company that needs large capital to run a business may have a high ratio compared to other companies like software.
Analyze the company's historical data for better analysis. If the ratio of debt to EBITDA is decreasing over the year, either the company is reducing its debt or increasing its EBITDA. On the other hand, if the debt to EBITDA ratio is increasing over a year, this may indicate either an increase in debt or a decrease in EBITDA.
Compare companies that operate in the same industry as the debt to EBITDA ratio differs from industry to industry. Every industry has different capital requirements.
For better analysis, we cannot depend on one particular ratio. So use other financial metrics with Debt to EBITDA Ratio like Debt to Equity Ratio
, Debt to Assets
, CFO to Debt
| Strong Bullish
|1 to 2
|Almost Debt Free
|2 to 3
| Mild Bullish
|3 to 4
|4 to 6
| Mild Bearish
|6 to 8
|High Debt Burden
| Strong Bearish
|Extremely High Debt Burden