Net debt/EBITDA: when a company starts to become dangerous

Net debt to EBITDA is one of the most widely used thermometers for measuring a company’s financial risk. It indicates how many years of operating profit (before interest, taxes, depreciation and amortization) the company would need to repay all of its net debt.

How it is calculated

You take total debt, subtract cash and equivalents (hence "net") and divide the result by annual EBITDA. A ratio of 2.0 means the company would take about two years to repay its debt if it devoted all of its operating profit to it.

What levels to watch

• Below 1.0: a very solid balance sheet, plenty of room to maneuver.
• Between 1.0 and 3.0: the usual, manageable range for most sectors.
• Above 3.0-4.0: the watch zone begins; the company is vulnerable to rate hikes or falling profits.
• Well above 4.0-5.0: high risk, except in very stable, regulated sectors.

Context is everything

The same ratio means different things depending on the business. A regulated utility with predictable revenue can sustain more debt than a cyclical or technology company with volatile profits. The maturity schedule and average cost of debt also matter: owing a lot at a fixed, long-term rate is not the same as at a variable, short-term rate.