Debt to EBITDA and Capital Structure
A leverage ratio is a date and a definition. Read both before the number.
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
Leverage measures how much debt a business carries against what carries it. Debt to EBITDA asks how many years of earnings the debt represents; gearing, debt to equity, asks how much of the business the lenders fund against the owners. Banks count committed facilities, say whether cash is netted off, and read the ratio at the peak of a seasonal business rather than its year-end. The number is only as good as the EBITDA underneath it, and the question behind all of them is whether the debt can come down.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
// MAKE THE CALL
Issue 04 — Highview Industries. Same request as Issue 01 on the surface. A completely different file underneath. Your call first, then the senior banker's.
// FOUR WAYS TO MEASURE IT
Leverage asks how much debt a business carries against what carries it. Against earnings, it is a question about capacity: how many years of EBITDA the debt represents. Against the owners' money, it is a question about who is funding the business. Each has a variant that answers slightly differently, and each misleads in a particular way.
| Dimension | WHAT IT ASKS | WHERE IT MISLEADS |
|---|---|---|
| TOTAL DEBT ÷ EBITDA | WHAT IT ASKSHow many years of earnings the debt represents. | WHERE IT MISLEADSOn a single date: debt that peaks in the season is not in it. |
| NET DEBT ÷ EBITDA | WHAT IT ASKSThe same, after the cash the business holds. | WHERE IT MISLEADSWhen the cash is working capital, or at its seasonal high. |
| SENIOR DEBT ÷ EBITDA | WHAT IT ASKSHow much ranks first, against the same earnings. | WHERE IT MISLEADSAlone: junior debt still has to be paid from the same cash. |
| DEBT ÷ EQUITY (GEARING) | WHAT IT ASKSHow much of the business the lenders fund against the owners. | WHERE IT MISLEADSWhere equity is mostly intangible, or assets are carried above what they would fetch. |
// 01 — THE YEAR THE DEBT ARRIVES
Highview Industries, in Issue 04, borrowed to build a new line in FY24. Its leverage, total debt over EBITDA, moved like this:
FY24 US$7.90m ÷ US$3.65m = 2.16×
FY25 US$7.60m ÷ US$4.71m = 1.61×
The jump is the plant loan landing before the volume it was built for. The fall is worth taking apart. Had the debt stayed at its FY24 level, FY25's higher EBITDA alone would have brought the ratio to 1.68×: 0.49 of the 0.55 fall is earnings growing into the debt, and 0.06 is debt repaid. That is the normal shape of an investment that works, and the reason a desk asks what the ratio will be in two years, not only what it is today.
The same FY25 reads 1.49× on net debt, after US$0.57m of cash, and 2.02× with the revolver drawn to its proposed US$4.0m limit — the figure the facility's 2.5× covenant has to be tested against, because committed debt can be drawn on the worst day.
// 02 — AGAINST THE OWNERS' MONEY
Gearing puts the debt against equity. Highview's US$7.60m of debt against US$10.09m of shareholders' funds is 0.75 — the owners still fund more of the business than the bank does. Meridian Logistics, in Issue 05, has no debt at all today; the US$6.0m it asks for would be 1.41× its FY25 EBITDA and 0.44 of its equity.
On both measures Meridian is the lighter borrower, and it is the harder file. Neither ratio can see that 58% of the earnings that would carry the loan come from one customer on a ninety-day break clause. Leverage measures how much debt there is; it says nothing about how many places the cash to repay it comes from.
// 03 — THE DEBT A YEAR-END MISSES
Kowhai Retail Group, in Issue 06, reports no bank debt at its year-end, because the year-end falls after the February clean-down. At last season's peak it owed US$2.6m across its seasonal line and overdraft:
Peak: US$2.60m ÷ US$1.26m = 2.06×
For a seasonal business the balance-sheet date is chosen by the calendar, not by the risk. A desk reads leverage at the peak of the cycle, from the facility's drawing history, and treats the year-end figure as the least informative number in the file.
// 04 — WHAT THE EBITDA IS MADE OF
Every leverage ratio is only as good as the earnings underneath it. In Issue 07, Coastline Retail Group reports net profit up 9%, with its covenants clean — measured on reported EBITDA. Take out a released provision and a change in when supplier rebates are recognised and the underlying profit is down by about a third. The covenants inherit every one of those choices; a leverage ratio on the same EBITDA would have looked better than the business was.
Supervisors say the same thing from the other side: in a leveraged deal, adjustments that add to EBITDA should be justified and reviewed independently, and the question to ask is whether the borrower can repay or reduce the debt from its own cash within a reasonable time.
// STANDARDS THIS SITS BESIDE
The recognised ground this page sits beside. Each was opened and checked when cited; none is a source for the framework itself.
- European Banking Authority, Guidelines on loan origination and monitoring (EBA/GL/2020/06), section 5.2.9, paragraphs 182–183 — Banks should identify excessive leverage at origination, measured as total debt to EBITDA, and escalate it with a full assessment of the borrower's capacity to repay or delever within a reasonable time.
- ECB Banking Supervision, Guidance on leveraged transactions (May 2017), section 3, footnotes 6–7 — Total debt counts drawn and undrawn committed facilities, without netting cash, calculated pro forma; adjustments to EBITDA must be justified and independently reviewed — sections 01 and 04 on this page.
- OCC, Comptroller's Handbook: Rating Credit Risk (April 2001, updated 2017), appendix F, elevated leverage ratio, page 63 — Acceptable leverage varies by industry and loan; it may be measured as debt to worth or debt to cash flow, and the ratio's definition should be checked — the reason this page sets each figure against its own file.
- OCC and FDIC, Interagency Statement on Withdrawal from the Interagency Leveraged Lending Guidance Issuances (OCC Bulletin 2025-44), principles 5–6 — Underwriting should weigh the loan's purpose, its sources of repayment and the capacity to delever over a reasonable period, testing projections against past and current performance.
// QUESTIONS PEOPLE ASK
- What is the debt to EBITDA ratio?
- Total debt divided by a year's EBITDA — how many years of earnings, before interest, tax and depreciation, the debt represents. Banks usually count committed facilities, not just what is drawn on the day, and state whether cash is netted off. It is the most common measure of leverage in business lending because EBITDA approximates the earnings available to service debt before the capital structure takes its share.
- What is a good debt to EBITDA ratio?
- It depends on the business, and this site does not publish a band. A business with stable, contracted earnings and assets that hold their value can carry more than one whose earnings swing with a season or a single customer. A bank's policy and each facility's covenant set the limit for that borrower, and the ratio means little without knowing how the debt and the EBITDA were defined.
- What is the difference between leverage and gearing?
- Leverage in lending usually means debt against earnings — debt to EBITDA. Gearing means debt against the owners' funds — debt to equity, or to tangible net worth once intangible assets are taken out. The first asks whether earnings can carry the debt; the second how much of the business the lenders are funding compared with the owners. A bank reads both, because each can look comfortable while the other does not.
- What is net debt?
- Borrowings less the cash the business holds. It is a fairer measure when cash balances are large and genuinely free, and a flattering one when the cash is needed to run the business or sits at a seasonal high on the balance-sheet date. Many facility documents define leverage on total debt for that reason.
- What is senior leverage?
- Leverage counting only the debt that ranks first for repayment — usually the secured bank facilities — while total leverage counts everything, including subordinated or shareholder loans. A senior lender cares about both: senior leverage for its own position, total leverage for whether the business can carry all its obligations.
// THE LOAN THAT ARRIVED BEFORE THE VOLUME
Highview's three years of accounts are open above its question — the plant loan in FY24, the earnings that grew into it, and the request that followed.
Open Issue 04's file →