Whilst financial markets have been through a lot of changes in recent years (banks in particular) and there is more to come, it is good to know that some things never change.
One lending covenant, or financial covenant, which has regained favour in recent years is the old question “how much debt should I have relative to my cash flow?”.
This is known as Gross Leverage Ratio and is represented by the formula:
Total Debt ÷ Rolling 12 months EBITDA
- Total debt includes all external/bank term debt facilities.
- EBITDA = earnings before interest, tax, depreciation and amortisation.
- As a rule of thumb, the ratio should be <2.5 times (*exceptions apply).
Whilst cash flow and working capital have always been the starting point in any financial analysis and debt/leverage has always been included in any financial covenants, the relationship between debt and cash flow has returned to prominence in recent years as an important metric.
Pre-GFC, Cash was deducted from Total Debt but the thought now is that cash will be utilised in a stressed business, so Total Debt relative to EBITDA is a more appropriate measure.
At the end of the day, it makes sense for business owners to keep this ratio in mind when it comes to financing their business. Any questions please ask your Ledge Finance Executive or contact us here.
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