When it comes to financing companies, the measure of net debt plays an important role in the analysis of a company and company valuation. In this article, we will therefore show you how the key figure net debt ratio is defined and calculated and what meaning and meaningfulness are inherent in it.
The ratio net debt ratio sets the net debt of a company (ie debt less liquid or quickly liquidizable assets) in relation to its earning power.
The net debt ratio is alternatively and in English also referred to as Net Debt / EBITDA, which actually already said the most important thing to the calculation:
It is calculated by dividing the net debt (net debt) by the EBITDA of the respective financial year. So the formula is: Net debt / EBITDA.
Thus, if a company had a net debt of EUR 1,000 at the end of the financial year and had an EBITDA of EUR 250, the net debt ratio is 4.0x.
The EBITDA in the above example and the relevant fiscal year therefore fits four times into the current net debt of the company.
The representation with the “x” behind the indication of the net debt ratio is common. This displays the capacitive nature of the measure. Incidentally, the same presentation is also made for the interest cover ratio .
Statement and explanation
As stated above, the net debt ratio at first glance shows how often the company’s EBITDA fits in with the current net debt. That alone is an interesting piece of information.
Turning this idea around, but you come to the really important statement of the ratio net debt ratio: Because the net debt ratio says in reverse so synonymous, how long the company (with the same EBITDA) would need to repay the current net debt. In our example above exactly four years. Again: At constant EBITDA!
The net debt ratio is not only very popular in the financial analysis of companies. Instead, net debt is, in our experience, the most popular financial covenant .
Both are in our opinion due to the versatility of this ratio, which is reflected in three factors:
- The net debt ratio relates a balance sheet value (net debt) to a value of the income statement (EBITDA).
- It creates a connection between the financing or indebtedness of a company and its earning power.
- It combines a relatively rigid value (net debt) with a very dynamic one (EBITDA).
As a result, this key figure is particularly suitable for getting a first impression of a company’s financing , capital resources and earning power. However, in its use as a financial covenant , it is ideally suited to agreeing on a target development of the financial overall situation of a company and tracking it over time.
We like to associate the net debt with the interest cover ratio to the financial covenants.
The net debt ratio is to be distinguished from the Gearing indicator. In contrast to the former, the debt is not set in relation to the profitability of the company but to the equity in the case of the latter key figure. Gearing is thus a significantly less dynamic key figure than the net debt / EBITDA and can rather be compared to the classic leverage (ie FK / EK), as it is also known from the area of derivatives (options).
Negative net debt
Although a negative level of net debt is rare, it is nevertheless occasionally encountered in the financial analysis of companies.
The solution to this apparent folly is that either the net debt or the EBITDA of the company in question is negative.
Both are possible in principle:
Since net debt is only a netting out of a value of liabilities (gross debt) and assets that can be quickly liquidated, it can assume negative values.