Decoding EBITDA: How Lenders Use This Crucial Metric

Understand how to calculate EBITDA, why it’s a vital measure for business valuation, and its critical importance to lenders when assessing loan eligibility and risk. SEO focused on ‘what is ebitda?’.

December 15th, 2025

Every commercial lender, private equity investor, and serious business owner uses one key financial metric to gauge operational health and valuation potential: EBITDA.

If you’ve ever asked “what is EBITDA?”, you’re most certainly not alone. It’s often misunderstood, yet it is arguably the most vital performance measure when securing funding. At Lime Finance Solutions, we use EBITDA as a foundational tool to assess a business’s capacity for debt because that is what lenders do and our clients benefit from understanding how lenders act.

“In corporate loan agreements, lenders often focus on adjusted EBITDA because it provides a clearer picture of a company’s ability to generate cash flows from its core business activities. By adjusting for non-recurring expenses, one-time charges, or other items that may distort the company‘s financial performance, lenders can better evaluate the borrower’s capacity to meet its debt obligations.”
(Source: Haynes Boone, “EBITDA Adjustments in Loan Negotiations”)

What is EBITDA and How is it Calculated?

EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortisation.

In simple terms, EBITDA is a proxy for the cash profit a business generates purely from its core operations. By stripping out costs related to financing (Interest), government (Taxes), and accounting conventions (Depreciation and Amortisation), it aims to show the “pure” operational profitability before capital structure decisions and non-cash items muddy the waters.

Lenders use EBITDA when measuring commercial borrowing affordability, unfortunately many business owners fail to understand it’s significance.

The EBITDA Calculation Formula

EBITDA can be calculated in two primary ways, starting either from the top of the Income Statement or the bottom:

The Bottom-Up Method (The Add-Back): Net Income + Depreciation + Interest + Amortisation + Tax
The Top-Down Method (The Operational Approach): Cost of Good Sold – Operating Expenses (less depreciation & amortisation)

While simple in concept, the key to accurate calculation lies in correctly identifying and excluding those non-operational and non-cash expenses.

For the majority of SMEs the easiest calculation is the first method given the annual accounts will not contain a detailed cash statement.

Why EBITDA is Used Differently for Different Audiences

One of the reasons EBITDA is often scrutinised is its flexibility, which can lead to it being “used differently” across various stakeholders:

For Business Management: Management uses it to compare the operational efficiency of different departments, subsidiaries, or projects, irrespective of different local tax codes or capital investments (which drive D&A).
For Investors (Valuation): Private equity firms and buyers use EBITDA as the basis for valuation multiples (e.g., selling a company for 5x EBITDA). It allows for apples-to-apples comparisons between companies in the same sector, even if one is heavily leveraged and the other has few assets.
For Lenders (Adjusted EBITDA): This is where the calculation becomes most nuanced. Lenders rarely use the standard figure. Instead, they focus on Adjusted EBITDA (or Maintainable EBITDA). This figure includes “add-backs” or “subtract-aways” for one-off, non-recurring events that distorted the historical figure, such as:
- One-time legal fees.
- Extraordinary owner/director salaries.
- Severance pay for restructuring.
- Unusual gains or losses on asset sales.

Lenders use Adjusted EBITDA because they need to determine the expected, sustainable future profit that will be available to service the debt. Remember, it is this that lenders use to assess loan affordability, not profit.

Why EBITDA is Critical to Lenders

For financial institutions, EBITDA is the single most important metric for two reasons: Capacity and Covenant Setting.

A. Assessing Debt Service Capacity

Lenders are interested in the amount of cash profit generated by the business before any existing debt obligations are met. This is primarily done via the Debt Service Coverage Ratio (DSCR):

Adjusted EBITDA / Total Annual Debt Service

A DSCR of 1.25x or higher is usually considered healthy but lenders have different levels they requires depending on structure, industry and borrowing purpose.

If a business has a strong Adjusted EBITDA, it signals a lower risk of default, in theory making it eligible for better rates and larger loans.

It is worth noting that lenders may measure ‘total annual debt service’ as the capital & interest repayment cost or just the interest only. It is also worth noting that with property investment transactions lenders will often judge debt service using the net or gross rent alone. We can let you know what lenders use what and guide you accordingly – don’t panic. You can also calculate your mortgage or finance costs here.

B. Setting Financial Covenants

Lenders often include financial safeguards called covenants in loan agreements. The most common covenant is tied directly to EBITDA: the Leverage Ratio.

Leverage Ratio = Total Debt / Adjusted EBITDA

A lender may impose a covenant stating that the company’s Leverage Ratio must not exceed, say, 3.5x. If the business’s EBITDA suddenly drops, causing this ratio to spike above 3.5x, the company would be in technical default, allowing the lender to intervene and protect their investment.

This means that where covenants exist then having a conversation with your accountant before filing year end accounts can really help. AI will gradually check these covenants, getting ahead of the game will become ever more important to avoid lenders leaning on personal guarantees because covenants have been breached.

In summary, for lenders, EBITDA provides a clean, comparable, and actionable measure of a business’s operational firepower, making it central to both risk assessment and ongoing loan management.

EBITDA When Borrowing

The key message is not about being able to accurately calculate EBITDA, it is about understanding why lenders use it then letting us help with the finer details. We always look at affordability before putting any application together.

As AI takes a stronger grasp of credit assessment the calculation of EBITDA will become more automated, it will become ever more important for SMEs to have an understanding key metrics.

If you want more details then get in touch.

Frequently Asked Questions (FAQ)

Q: Is EBITDA the same as cash flow?

A: No, don’t make this mistake. While EBITDA is a proxy for operational cash flow, it is not true cash flow. EBITDA excludes changes in working capital (like debtors and creditors) and capital expenditure (CapEx), both of which are critical elements of actual free cash flow. A company can have a high EBITDA but struggle with cash flow if, for example, it has massive CapEx needs or uncommonly low depreciation.

Q: Why do we add back Depreciation and Amortisation (D&A)?

A: D&A are non-cash expenses. Whilst they are included within a business P&L they are not true ‘cash’ costs. They reflect the accounting cost of using an asset over time, but they do not involve an actual cash outlay in the current period. Lenders add them back to get a clearer picture of the operational cash generated before capital structure (financing) costs.

Q: Is a higher EBITDA always better?

A: Generally, yes, a higher EBITDA indicates greater operational profitability. However, context matters. It’s more important to look at the EBITDA Margin (EBITDA as a percentage of revenue) and to compare the figure against sector peers and historical performance. This is where a company having the correct SIC matters.

Q: Should a business use EBITDA in its official financial reporting?

A: EBITDA is an non-GAAP (Generally Accepted Accounting Principles) measure and is generally not permitted as the final measure of profitability on official financial statements. It should be used as a supplementary metric to Net Income, not a replacement. Lenders use it because profit does not repay borrowing, cash does.

David Farmer

Over 30 years finance experience. Former credit underwriter, founder of Lime Finance Solutions in 2012. Multi Award winning business, featured in Sunday Telegraph, Parliamentary Review, Sky TV and others. Regular contributor to press and business associations. FCA Authorised, ALIBF Qualified. Specialist in Commercial Mortgages, Business Lending, Property and Development Finance.