Gearing—also called leverage ratio—is a key metric that describes the relationship between a company's debt and its earnings power. In Danish loan agreement contexts, it is typically calculated as total debt divided by annual EBITDA (Total Debt / EBITDA). If debt is 40m kr. and EBITDA is 10m kr., gearing is 4.0×—the company owes the equivalent of 4 years of operating earnings.
Gearing = Total debt / Annual EBITDA
If debt is 40m kr. and EBITDA is 10m kr., gearing is 4.0×. In other words: the company owes the equivalent of 4 years of operating earnings.
Why does the bank use gearing?
The bank uses gearing because it is the simplest way to answer the question: How long would the company need to repay the loan from operations? The higher the gearing, the longer the repayment period—and therefore the higher the risk for the lender.
What is a typical gearing threshold?
In Denmark we typically see covenants at:
- 3.0×–3.5× for more conservative loans and smaller companies
- 4.0×–4.5× for mid-sized companies with stable earnings
- 5.0×–6.0× for private-equity-owned or leveraged transactions
The threshold depends on industry, earnings quality, and collateral.
Net debt or total debt?
Some loan agreements use net debt—i.e. total debt minus cash. This gives a lower gearing if the company holds cash. Check exactly how your own loan agreement defines it, as it can make a significant difference near the threshold.
What if EBITDA falls?
This is the hidden danger of gearing covenants. If EBITDA falls 10%, gearing rises automatically—even if you haven't taken on new debt. A company with gearing of 3.2× and a covenant of 3.5× can breach simply by EBITDA falling 10%.
That's why a drop in operations often triggers a covenant breach long before the company runs out of cash.