Leverage ratios measure a company's indebtedness and its ability to repay that debt. Let's start by looking at a bit of terminology, which is net debt. Net debt is your debt less your cash and it looks at a company's true indebtedness. Imagine I had debt of 100 but I had cash of 99. Well, actually, my true indebtedness then is really just one. Now let's look at the ratios. We've got debt to EBITDA which is your debt over EBITDA or your net debt over EBITDA, and this tests the ability to repay debt. Imagine that your EBITDA is cash available to pay debt. That's not quite true but it's quite a nice way to think of it. If my debt was 100 and my EBITDA was 50, then that means it's going to take me two years of EBITDA to pay off my debt. A bank looking to lend some money to this company might think two times two years of EBITDA, that sounds okay, no problem. Whereas if your debt to EBITDA ratio was eight times, that would be a very high amount of debt. It's gonna take you a long time to pay that debt off. A bank is going to be less likely to lend you money in that case. Next up, we have the debt to equity ratio. That's debt over equity or debt over debt plus equity and it's a measure of non-equity finance to equity finance. Imagine again that your debt was 100 and your equity was 200, so this would come out as a .5 ratio. Well, again, banks appraising this company might look at this and think, the debt holders are taking a bit of risk but the equity holders are taking more. Banks are putting 50, equity holders are putting 100. The equity holders are taking a lot of risk. I might be willing to lend them a bit more. Whereas if the debt equity ratio were three, so my equity is 100, but my debt is 300, then the banks would say that the equity holders aren't taking as much risk as the banks. The banks are actually taking a very high amount of risk. They're funding 300 to the business whereas the equity holders are only funding 100. That company would be very unlikely to get any more debt funding.

And lastly, the interest coverage ratio, that's your EBITDA over interest expense and that tests the ability to repay interest. Again, we need to think about EBITDA here as a bit like cash that could be used to pay off interest.

The more EBITDA you've got to your interest expense, then that means the greater number of times your interest could be covered. So if your EBITDA is 100 and your interest expense is 50, that means you could pay your interest two times over. Banks might look at that and think, hmm, okay, you could pay our interest twice. That's just about okay. But if you could pay your interest five times or 10 times or 20 times, banks would feel much happier about that. So our leverage ratios are used to work out a company's ability to repay their debt and their level of indebtedness.