Debt to EBITDA Ratio Explained: Key Metric Lenders Use to Approve Business Loans

Whether you're applying for a working capital loan or a ₹100 Cr term loan, one number can make or break your funding: the Debt to EBITDA ratio. 

Lenders and investors use this metric to quickly assess how well your business can repay debt based on current earnings. Let’s break it down.

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What is Debt to EBITDA Ratio?

The Debt to EBITDA ratio is a financial metric that compares a company’s total debt to its EBITDA. It essentially indicates how many years it would take for a company to repay its debt if it used all its earnings for this purpose. 

This ratio is important because it provides a snapshot of a company’s debt dependence, the degree to which it relies on borrowed funds and its capacity to meet debt obligations.

The formula for the Debt to EBITDA ratio is simple:

Where:

• Total Debt: Includes all short-term and long-term interest-bearing liabilities (loans, bonds, etc.).
• EBITDA: Earnings before interest, taxes, depreciation, and amortization—a measure of operating performance.

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Why Debt to EBITDA Ratio Matters?

1. Assessing Leverage: It shows how much debt a company is carrying relative to its earnings.
2. Evaluating Creditworthiness: A low ratio signals financial stability and repayment ability.
3. Understanding Liquidity: It indicates how easily a business can manage debt without cash flow strain.

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How to Calculate Debt to EBITDA Ratio?

Let’s walk through a simple example to calculate the Debt to EBITDA ratio.

Example:

• Short-Term Debt: ₹50 million
• Long-Term Debt: ₹150 million
• EBITDA: ₹100 million

Total Debt = ₹50 million + ₹150 million = ₹200 million

Now, applying the Debt to EBITDA formula:

• Debt to EBITDA Ratio = Total Debt / EBITDA
• Debt to EBITDA Ratio = ₹200 million / ₹100 million = 2.0

This means that the company would take 2 years to pay off its total debt using its EBITDA, assuming no changes in debt or EBITDA.

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How to Interpret the Ratio?

• Below 2.0: Low risk. Strong ability to service debt.
• 2.0 to 4.0: Moderate risk. Manageable but requires close monitoring.
• Above 4.0: High risk. May indicate cash flow issues and financial stress.

Note: Always compare the ratio to your industry average for meaningful insight.

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Why Debt to EBITDA Ratios Vary by Industry?

• High Ratios (Capital-Intensive Sectors): Infrastructure, telecom, and energy often operate with higher debt due to heavy upfront costs. Ratios above 4.0 may still be considered normal here.
• Low Ratios (Asset-Light Sectors): Technology, SaaS, and services companies usually maintain lower leverage. A ratio above 3.0 could raise red flags.

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Strategic Use of Debt to EBITDA

For growing businesses, this ratio supports smarter decisions on:

1. Debt Capacity: Understand how much more you can borrow safely.
2. Investor Readiness: Lower ratios attract investors seeking financial discipline.
3. Loan Covenants: Lenders often include ratio limits in contracts; exceeding them can trigger penalties or restructuring.

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Limitations of Debt to EBITDA Ratio

While the Debt to EBITDA ratio is an essential tool, it has limitations:

• Excludes Interest Payments: It doesn’t reflect actual cash outflows for interest.
• Ignores Capex: EBITDA doesn’t account for necessary reinvestments in assets.
• Not Universally Comparable: Needs to be evaluated within the industry context.

To address these challenges, there are collateral-free funding solutions available, offering loans up to ₹10 crores for SMEs and high-growth companies.

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Conclusion

The Debt to EBITDA ratio is a powerful tool for measuring financial health, but it’s just one part of a bigger picture. For Indian SMEs and high-growth companies, staying on top of this metric can help balance risk, attract funding, and make more informed financial decisions.

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