Julian Shocron: How Heavy Is the Debt? Reading Debt-to-EBITDA
Julian Shocron looks at three quick ratios that help judge whether a business carries a light or a heavy debt load: debt-to-EBITDA, net debt-to-EBITDA and interest coverage.
What does debt-to-EBITDA measure?
Divide total debt by one year of EBITDA and you get a figure expressed in "times". It gives a rough answer to a simple question: how many years of EBITDA would it take to repay everything owed, if every bit of it went to the lenders?
It is a rough answer on purpose. EBITDA is not spare cash; taxes, interest and reinvestment come first. Treat the ratio as a quick gauge, not a repayment schedule.
Why subtract cash to get net debt?
Cash sitting in the bank could be used to pay part of the debt off. Net debt reflects that:
Net debt = total debt − cash
Two businesses with identical borrowings are not in the same position if one holds a healthy cash balance and the other holds almost none. Net debt-to-EBITDA picks up the difference.
What is interest coverage?
It shows how many times operating income could pay the year's interest bill:
Interest coverage = operating income ÷ interest expense
Debt-to-EBITDA looks at the size of the debt; coverage looks at the yearly cost of carrying it.
How do the numbers work for the bakery? (Fictional figures, illustration only)
The bakery from the other notes owes 200, holds 30 in cash, and reports 170 of EBITDA, 150 of operating income and 20 of interest.
| Ratio | Calculation | Result |
|---|---|---|
| Debt-to-EBITDA | 200 ÷ 170 | ≈ 1.2x |
| Net debt | 200 − 30 | 170 |
| Net debt-to-EBITDA | 170 ÷ 170 | 1.0x |
| Interest coverage | 150 ÷ 20 | 7.5x |
Put plainly: the debt is worth a little over one year of EBITDA, exactly one year once cash is netted off, and operating income covers interest seven and a half times.
What happens in a bad year?
The ratios can move even when the debt stays put. Imagine a weak year cuts EBITDA to 100; with depreciation still at 20, operating income falls to 80.
| Ratio | Normal year | Weak year |
|---|---|---|
| Debt-to-EBITDA | ≈ 1.2x | 200 ÷ 100 = 2.0x |
| Interest coverage | 7.5x | 80 ÷ 20 = 4.0x |
Nothing new was borrowed, yet the same debt feels almost twice as heavy. That is why these ratios are worth tracking across several years rather than in one snapshot.
Where do these ratios fall short?
- They lean on EBITDA, which ignores reinvestment and tax. Read them next to free cash flow, which for the bakery is 35.
- There is no universal "right" level. A business with very steady sales can usually handle more debt than one whose sales swing.
- Definitions vary. Some analyses count long-term leases or other obligations as debt, so check what went into each calculation.
Key points
Debt-to-EBITDA tells you how many years of EBITDA the debt represents; the net version deducts cash; interest coverage shows how many times operating income pays the interest. For the fictional bakery, the three come to about 1.2x, 1.0x and 7.5x.
Educational note by Julian Shocron. Not investment advice.
More notes by Julian Shocron: julianshocron.com/en