Net debt to EBITDA divides a company’s net debt by its EBITDA for the last twelve months, giving debt as a number of years of earnings. There is no official acceptable level: it depends on the sector, the lender and the definitions in the facility agreement. As reference points, the Bank of England treated listed companies at four times or more as highly leveraged in its 2020 analysis, and found the median for UK companies backed by private equity or private credit was about six times in 2026.

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How is the ratio calculated?

The basic formula is:

Net debt ÷ EBITDA

Net debt is borrowings and lease liabilities less cash (see net debt). EBITDA is earnings before interest, tax, depreciation and amortisation, normally for the twelve months to the test date (see EBITDA explained). A ratio of 3.0 means debt equals three years of EBITDA.

HMRC’s International Manual, which describes how third party lenders behave, explains at INTM517010 that the debt to EBITDA ratio measures the relationship between debt and profitability and is common in third party lending agreements for the general run of trading companies. EBITDA is used as an approximation of cash flow, and the same page notes it may be fine tuned, for example for non cash entries or actual capital expenditure.

Illustration only. A company has bank loans of £4.2m, lease liabilities of £0.6m and cash of £0.8m, so net debt is £4.0m. EBITDA for the last twelve months is £1.6m. Net debt to EBITDA is 4.0 ÷ 1.6 = 2.5 times. If a lender’s definition excludes leases, net debt is £3.4m and, if rent is then deducted in arriving at EBITDA, the figure moves again.

Where does the ratio appear in a loan agreement?

HMRC describes a typical senior or mezzanine loan agreement at INTM519070 as including an interest cover covenant, often EBITDA to interest, and a leverage covenant, often debt to EBITDA, sometimes backed by a cash flow covenant. Mezzanine covenants are often slightly more relaxed than senior ones. The page stresses that definitions of the elements, such as net interest and exceptional items, vary and must be read closely.

INTM517040 makes a further point worth remembering: covenant ratios act as triggers that alert the lender to poor performance, and they have only an indirect relationship to the amount actually lent. For example, and as an illustration only, a lender might advance funds at 2.5 times and set the covenant at 3.5 times to leave headroom.

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What levels do lenders look for?

There is no published standard. HMRC states at INTM517040 that it is impossible and undesirable to give debt to EBITDA ratios that apply across the board, and that the levels lenders require vary considerably between business types. Its guidance draws out several patterns:

  • for a business in a steady state, third party lenders’ offers fall in a fairly narrow range;
  • after an acquisition a lender may accept a temporary “debt spike”, with covenants that step down year by year towards steady state levels;
  • private equity backed businesses are likely to be more highly leveraged than traditional businesses.

The Bank of England gives useful market evidence. In its August 2020 Financial Stability Report it described listed companies with net debt to EBITDA greater than or equal to four as highly leveraged. In the July 2026 report, information gathered for its private markets exploratory scenario showed median leverage of about six times net debt to reported EBITDA for UK companies receiving private equity or private credit funding, with reported EBITDA meaning before management adjustments. Those are leveraged buyout figures, not a target for an ordinary trading company. Where lending is secured on property, INTM519070 notes the agreement may instead rely on a loan to value covenant. For cash cover rather than leverage, see debt service cover ratio.

How do leases change the ratio?

Bringing leases onto the balance sheet raises both sides of the ratio. The IASB’s effects analysis for IFRS 16 explains that EBITDA rises because lease costs become depreciation and interest, so that EBITDA under IFRS 16 corresponds to EBITDAR (before rent) under the old standard, while lease liabilities add to debt. The FRC’s Periodic Review 2024 amendments make the same change for FRS 102 reporters for accounting periods beginning on or after 1 January 2026.

Because debt rises by several years of rent while EBITDA rises by one year, the ratio usually increases for a business with long leases. The IASB found that many existing covenants were not directly affected, because “debt” and “EBITDA” are defined in the loan agreement rather than by accounting standards, and many agreements allow the borrower to keep using the standards in force when the loan was signed. HMRC calls this “frozen GAAP” at INTM515070.

Which adjustments move the answer?

Most arguments over leverage are really arguments over EBITDA. INTM515060 accepts that genuinely exceptional integration and restructuring costs may be disregarded, but warns that costs forecast to continue for several years should not be ignored, and exceptional gains should also be excluded. In a February 2019 speech the then Governor of the Bank of England noted that most leveraged loan deals had substantial “add backs” of EBITDA. Each add back lowers the ratio, which is why lenders test them; see normalised EBITDA and add backs.

Other common adjustments include annualising EBITDA of a business acquired part way through the year, deducting cash that is not freely available, and averaging net debt across the year where year end cash is unusually high.

What happens if the covenant is breached?

INTM519070 notes that a breach is typically taken very seriously and may lead to the borrower injecting more equity, repaying part of the loan, renegotiating the facility, or the lender calling in the loan. INTM515060 explains why covenants should be set with headroom so that a normal downturn does not cause a breach. A breach at the balance sheet date can also change how the loan is classified in the accounts; see breached loan covenants and classification.

What mistakes come up most often?

  • Quoting the ratio on accounting definitions when the covenant uses different ones.
  • Comparing a ratio including leases with a benchmark set before lease accounting changed.
  • Using adjusted EBITDA without disclosing the add backs.
  • Measuring net debt on the one day of the year when cash is highest.
  • Treating the ratio as a complete picture: it says nothing about repayment profile, interest rates or capital expenditure. Use it alongside gearing and cash flow measures.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 19 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.