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CFA Level I Exam · Credit Analysis for Corporate Issuers

Credit Ratios: Debt to EBITDA and Interest Coverage

Updated 7 October 2026 · Fact-checked

Credit ratios measure a borrower's ability to pay its debt. Leverage ratios, such as debt/EBITDA and FFO/debt, compare debt with earnings or cash flow. Coverage ratios, such as EBITDA/interest, compare earnings with interest cost. Compute each ratio from the same definitions, then judge whether leverage is high or coverage is thin.

Understand Credit Ratios and Financial Analysis of Issuers

Credit analysis asks one question: will the issuer pay interest and repay principal on time? Bondholders gain little from extra profit, so they care about downside protection. Credit ratios turn the financial statements into a few numbers that show how much cushion the issuer has.

There are two families. Leverage ratios show how large the debt is compared with the earnings or cash flow that must service it. Examples are debt/EBITDA, debt/capital and FFO/debt. For debt/EBITDA, lower is better. For FFO/debt, higher is better. Coverage ratios show how many times earnings or cash flow cover interest. Examples are EBITDA/interest and EBIT/interest. Higher is better.

EBITDA is earnings before interest, taxes, depreciation and amortization. It is a proxy for operating cash flow before capital spending. EBIT deducts depreciation and amortization, so it is lower than EBITDA. EBITDA coverage looks better than EBIT coverage. EBIT coverage is stricter because it recognises that assets wear out and must be replaced. FFO (funds from operations) is net income plus depreciation, amortization and other non-cash charges. Some ratings agencies add back interest for coverage versions of FFO. Use the definition the question gives.

Ratios are never judged alone. Compare them with the issuer's past, with peers, and with rating-category norms. Remember the limits. EBITDA ignores capex and working capital, so a firm can show strong EBITDA coverage and still burn cash. Analysts often adjust debt to include leases, pension deficits or other debt-like items. Cash-flow-based ratios such as FFO/debt and FCF/debt are harder to manipulate than earnings-based ones.

Key formulas to remember

Debt/EBITDA
Debt/EBITDA = Total debt ÷ EBITDA
Leverage. Lower means stronger credit. It is roughly the number of years of EBITDA needed to repay debt.
FFO/Debt
FFO/Debt = FFO ÷ Total debt
Leverage on a cash-flow basis. Higher means stronger credit. FFO = net income + depreciation, amortization and other non-cash items.
EBITDA interest coverage
EBITDA/Interest = EBITDA ÷ Interest expense
Coverage. Higher is better. It is more generous than EBIT coverage.
EBIT interest coverage
EBIT/Interest = EBIT ÷ Interest expense
Coverage. Stricter than EBITDA coverage because depreciation is deducted.
Debt/Capital
Debt/Capital = Total debt ÷ (Total debt + Equity)
Leverage on a balance sheet basis. Lower is better. Equity is usually book value.
Free cash flow/Debt
FCF/Debt = (CFO − Capex) ÷ Total debt
Higher is better. It captures the effect of capital spending that EBITDA ignores.
EBITDA to EBIT link
EBITDA = EBIT + Depreciation and amortization
Use this to convert between the two when only one is given.

How to solve Credit Ratios and Financial Analysis of Issuers questions

Use this method for any credit ratio question. It keeps definitions straight and shows you what the question is really testing.

  1. 1Identify the ratio asked for and whether it is leverage or coverage. This tells you which direction is good.
  2. 2Pull the exact inputs from the question. Check whether debt includes short-term borrowings, leases or other adjustments the question mentions.
  3. 3If EBITDA or EBIT is not given, build it from the figures you have: EBIT = EBITDA − depreciation and amortization.
  4. 4Calculate the ratio. Keep at least two decimals before comparing.
  5. 5Compare the result with the benchmark, peer or prior year given in the question. Decide whether credit quality is stronger or weaker.
  6. 6Check the denominator and numerator are on the same basis, such as both annual figures or both after the same adjustments.
  7. 7Eliminate the two options that fail on direction or arithmetic, then choose the remaining one.

Quickest way: Direction and definition check

When to use it: Use this when you have about 90 seconds and the question asks which ratio is better or how a change affects credit.

  1. Write L for leverage or C for coverage next to the ratio. Leverage ratios with debt on top improve when they fall. FFO/debt and coverage ratios improve when they rise.
  2. Check whether the numerator is EBITDA or EBIT. EBITDA is always at least as large as EBIT when depreciation is positive.
  3. Estimate the answer first. For example, 600 ÷ 150 is about 4, so an option near 0.25 is the inverse and can be eliminated.
  4. Pick the option that matches your estimate and the direction of credit quality.

Common mistakes in Credit Ratios and Financial Analysis of Issuers

  • Treating a higher debt/EBITDA as stronger credit.

    Students link higher ratios with better results, as with profit margins.

    Fix: Remember debt/EBITDA is years of earnings needed to repay debt. More years means more risk.

  • Using EBITDA when the question asks for EBIT coverage.

    EBITDA is the more common figure, so students reach for it automatically.

    Fix: Read the numerator in the question. If only EBITDA is given, subtract depreciation and amortization to get EBIT.

  • Inverting the ratio, for example computing EBITDA/debt instead of debt/EBITDA.

    Both forms appear in practice and the names look alike.

    Fix: The name tells the order: the first item is the numerator. Debt/EBITDA has debt on top.

  • Forgetting that FFO adds back non-cash charges to net income.

    Students confuse FFO with net income or with operating cash flow after working capital.

    Fix: Use FFO = net income + depreciation, amortization and other non-cash items unless the question defines it otherwise.

  • Concluding that strong EBITDA coverage means safe credit.

    EBITDA ignores capex, taxes and working capital needs.

    Fix: Check whether capex is heavy. Use EBIT coverage or FCF/debt to see the fuller picture.

  • Leaving out debt-like items when the question asks for adjusted debt.

    Students use only the balance-sheet borrowings line.

    Fix: If the question lists lease liabilities or pension deficits as adjustments, add them to debt before computing the ratio.

Worked examples

Example 1

An issuer reports EBITDA of €480 million, depreciation and amortization of €120 million, interest expense of €60 million and total debt of €1,920 million. What is its EBITDA interest coverage? A. 6.0x, B. 8.0x, C. 32.0x.

Show the solution
  1. EBITDA coverage = EBITDA ÷ interest = 480 ÷ 60 = 8.0x.
  2. Check the options: 6.0x would use EBIT of 360 (480 − 120 = 360, then 360 ÷ 60). That is EBIT coverage, not EBITDA coverage.
  3. 32.0x would be debt ÷ interest (1,920 ÷ 60). That is not a coverage ratio based on earnings.
  4. Only 8.0x matches the EBITDA definition.

Answer: EBITDA interest coverage is 8.0x (option B).

Example 2

Company X has EBIT of $300 million, depreciation and amortization of $100 million, interest expense of $80 million, FFO of $260 million and total debt of $1,300 million. What is its EBIT interest coverage? A. 3.75x, B. 5.00x, C. 16.25x.

Show the solution
  1. EBIT coverage = EBIT ÷ interest = 300 ÷ 80 = 3.75x.
  2. The question gives EBIT directly, so do not subtract depreciation again.
  3. Option B, 5.00x, equals EBITDA ÷ interest (EBITDA = 300 + 100 = 400; 400 ÷ 80 = 5.00). That uses the wrong numerator.
  4. Option C, 16.25x, equals total debt ÷ interest (1,300 ÷ 80). That uses debt instead of earnings.
  5. Only 3.75x uses EBIT over interest.

Answer: Option A is correct: EBIT interest coverage is 3.75x.

Exam tips

  • Always note the direction first. A quick L or C tag stops you picking the wrong end of the scale.
  • Watch whether the stem gives EBIT or EBITDA. Questions often hide a trap by supplying depreciation as a distractor.
  • Options are listed smallest to largest. Inverted ratios often appear as distractors, so estimate the answer before you look at them.
  • When a question compares two issuers, do both calculations on the same basis. A one-line check of the units saves marks.
  • If a question asks about limits of ratios, think of capex, working capital, lease treatment and the gap between book and market values.

Practice questions from Credit Analysis for Corporate Issuers

Credit Ratios and Financial Analysis of Issuers in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Credit Ratios and Financial Analysis of Issuers: frequently asked questions

What is the difference between EBIT and EBITDA interest coverage?

EBITDA coverage divides earnings before depreciation and amortization by interest. EBIT coverage divides earnings after those charges by interest. EBIT coverage is lower and more conservative because it recognises the cost of replacing assets.

How do you calculate FFO to debt?

Add depreciation, amortization and other non-cash charges to net income to get FFO. Divide FFO by total debt. Express the result as a percentage. A higher ratio means the issuer generates more cash from operations relative to its debt.

Is a high debt/EBITDA ratio good or bad for credit quality?

A high ratio is bad. It means it would take many years of EBITDA to repay the debt. Lower debt/EBITDA signals stronger credit quality, other things equal.

Do I need a calculator for credit ratio questions?

Most are simple division, so the BA II Plus or HP 12C is enough. For example, on the BA II Plus enter 480, press ÷, enter 60, press = to get 8. The skill tested is picking the right inputs, not complex keystrokes.