INTM578060 - Thin capitalisation: interest cover

Earnings before Interest, Tax, Depreciation and Amortisation - EBITDA

It is sometimes argued that since both depreciation and amortisation are non-cash items, they should be excluded from the calculation of interest cover. This gives rise to a form of interest cover known as EBITDA. Generally, it is not a good idea to depart from easily found audited numbers. Depreciation shown in the accounts, for example, is a measure of the consumption of assets, and should normally be an adequate measure of annual capital expenditure.

If depreciation and amortisation are added back to the profit calculation, then clearly the apparent interest cover will increase. In order to decide the extent to which this is a valid thing to do, one needs to consider what the purpose of the calculation is (see INTM578010). Depreciation and amortisation need to be considered separately (see INTM578070 and INTM578080 respectively).

It is not uncommon to see, as a substitute for debt: equity ratio, a ratio of total debt to EBITDA as a cap to total borrowing. For example, if the debt: EBITDA ratio is 4:1, then the total borrowing is governed by the sustainable earnings as indicated by EBITDA.