Net Debt to EBITDA: How to Calculate It and How Much Debt Is Too Much

The formula

Net debt = short-term debt + long-term debt + lease liabilities − cash and marketable securities
EBITDA = operating income (EBIT) + depreciation + amortisation
Net debt to EBITDA = net debt ÷ EBITDA

The ratio answers a lender's question: if every dollar of operating cash profit went to repaying debt, how many years would it take? Net debt rather than gross debt, because cash on hand could repay part of the borrowing tomorrow. EBITDA rather than net income, because it is the profit available before the costs of financing and before the non-cash charges for past investment, which makes it comparable across companies with different debt levels and asset ages. Both numbers come from the filings: debt and cash from the balance sheet and its debt note, EBIT from the income statement, depreciation and amortisation from the cash flow statement.

Quote the result with one decimal place and the year it was measured on: "0.9× on last year's EBITDA" says more than "under 1×", because the denominator is the part that changes.

Worked example (illustrative)

Harbor Foods, the fictional company used across these guides, has $300 million of debt including leases and $100 million of cash, so net debt is $200 million. Its income statement shows $175 million of operating income, and the cash flow statement adds back $55 million of depreciation and amortisation, so EBITDA is $230 million.

Harbor could clear its net debt from less than a year of EBITDA, covers its interest nearly twelve times over, and would need two years of free cash flow to repay it after funding its own investment. All three say the same thing: the debt is comfortably carried. The third ratio is the strictest, because free cash flow comes after capital spending, interest and tax, which EBITDA ignores; the free cash flow formula article shows where that figure comes from.

How much is too much

There is no single threshold, because the right level depends on how stable the cash flows are. As conventions rather than rules:

Businesses with steady, contracted cash flows carry more comfortably: regulated utilities, telecom networks, infrastructure and property companies routinely run at 4× to 6× because their revenue barely moves with the economy. Cyclical businesses should run lower, because the EBITDA in the denominator can halve in a recession while the debt does not. A 2× ratio at the top of a cycle can be 4× at the bottom with no new borrowing at all, and that is where the value trap article's cheap stocks come from. Rating agencies and loan covenants set their own bands, and a company's debt note often states the covenant level, which tells you how much room it has.

What the ratio hides

• Capital spending. EBITDA is before the investment needed to keep the business running. A capital-heavy company at 2× can be more stretched than a capital-light one at 3×. Net debt to free cash flow corrects for it.
• Interest rates and maturities. Two companies at the same ratio differ if one pays 4% on bonds due in ten years and the other 9% on a loan due next year. Read the debt note for rates, maturities and whether the rate floats.
• Leases. Lease liabilities are debt and now sit on the balance sheet; include them, and use an EBITDA that is before rent to match, or exclude both consistently. Retailers and airlines move most.
• Pensions and other claims. An unfunded pension deficit, preferred stock or guaranteed debt of a subsidiary is a claim ahead of shareholders that the simple formula omits.
• Adjusted EBITDA. Companies and their lenders define EBITDA with add-backs for restructuring, stock compensation and "one-off" items. The covenant number can be a turn lower than the reported one. Use the reported figure for your own view.
• Restricted or trapped cash. Cash held abroad, in regulated subsidiaries or as collateral cannot repay the parent's debt; netting it flatters the ratio.
• The denominator's year. One strong year makes any debt look light. Use the average of the last three years, or the worst of them for a cyclical company.

The ratios to read beside it

Leverage is best judged with three numbers together:

1. Net debt to EBITDA for the size of the debt against operating profit.
2. Interest coverage, operating income divided by interest expense, for whether the profit can carry the cost of the debt. Below about 3× is uncomfortable for most businesses; below 1.5× the company is working for its lenders.
3. Net debt to free cash flow for how long repayment would really take after the business has funded itself.

Enterprise value ties them to valuation: a leveraged company's equity is a thin slice of the whole, so a small change in the business value moves the shares a lot, as the enterprise value vs market cap article shows. In a stock screen, a leverage ceiling such as net debt to EBITDA below 3× and interest coverage above 4× removes the companies whose cheapness is the market pricing financial risk; the value stock screener article includes one. VALYSTR's company pages compute these from the filed balance sheet and income statement, with leases included.