Debt EBITDA Ratio

The ability of a Company to be able to service its Debt obligations is of critical importance for Equity Investors. Debt EBITDA is one ratio to use. It is quick and easy to calculate.

In stock investing, one key issue to be aware of is how “at risk” your equity position is from excessive debt. The key issue is to understand if the Company can service the current level of Debt. There are various ratios to evaluate this, one is the Debt / EBITDA Ratio (Earnings before Interest, Tax, Depreciation Amortization). The Debt / EBITDA ratio measures the Operating Income generated, to cover its Debt obligations, when adding back the two non-cash items, depreciation and amortization.

Clearly the servicing of Debt is a Cash item. Keep in mind we are mixing a Balance Sheet item with a P&L item. Not all the Debt needs to be repaid in one year and Depreciation is there for Maintenance CAPEX. Therefore, it is difficult to use this ratio in isolation, but it is a useful indicator and easy to calculate. A high ratio, compared to other similar companies, could indicate that the debt burden could become excessive. Debt / EBITDA is a commonly used credit metric and Debt is senior to equity.