Debt-to-equity compares a company's borrowings with its shareholders' funds. How much of the business runs on borrowed money. Interest coverage compares operating profit with the interest bill — how comfortably the company can pay for those borrowings. The first measures how big the load is; the second, whether the legs can carry it.
How do I calculate them?
Farhan checks Kaveri Motors, our fictional vehicle maker. From its balance sheet: borrowings ₹250 crore, shareholders' equity ₹500 crore. From its P&L: operating profit before interest and tax (EBIT) ₹150 crore, interest cost ₹30 crore.
| Ratio | Formula | Kaveri Motors | Result |
|---|---|---|---|
| Debt-to-equity | Borrowings ÷ equity | 250 ÷ 500 | 0.5 |
| Interest coverage | EBIT ÷ interest | 150 ÷ 30 | 5 times |
A debt-to-equity of 0.5 means for every ₹1 of the owners' money there is 50 paise of borrowed money. Interest coverage of 5 times means operating profit could pay this year's interest bill five times over. Profits would have to collapse by 80% before interest became unpayable.
Lower debt-to-equity and higher coverage generally mean a safer company. But "safe" and "normal" depend on the industry: power and infrastructure companies routinely carry high debt against steady cash flows, while software companies often carry almost none. Compare within the industry and against the company's own history.
Why is debt a double-edged sword?
Borrowed money amplifies whatever the business does, exactly the way leverage amplifies a trader's position, as explained in what is leverage, and why is it risky. Same blade, corporate edition.
Watch it cut both ways. Suppose Kaveri Motors borrows an extra ₹500 crore at 10% to double a factory:
- Good year: the new capacity earns ₹100 crore of extra EBIT. Interest costs ₹50 crore, so shareholders keep an extra ₹50 crore they'd never have seen without the loan. ROE jumps. The pattern dissected in what are ROE and ROCE.
- Bad year: a slowdown wipes out the extra earnings. The ₹50 crore interest is still due, every year, in full. Profit that year falls below what the debt-free company would have made.
Equity forgives, no dividend is compulsory. Debt never forgives. Interest and repayments arrive on schedule whether the year was good or terrible. That asymmetry is why heavily indebted companies can be spectacular in booms and fragile in downturns.
What are the warning patterns?
- Coverage sliding toward 1–2 times. At 1x, the entire operating profit goes to lenders and shareholders keep nothing. Below 1x, the company can't earn its interest and must borrow more or sell assets to pay it.
- Debt rising faster than profits. Borrowing for growth is fine if the growth arrives; borrowing to plug operating losses compounds the hole.
- Short-term debt funding long-term assets. Loans that must be refinanced every year make the company hostage to lenders' moods.
- Debt with weak cash conversion. Interest is paid in cash, not accounting profit. A stretched borrower with poor operating cash flow is doubly fragile.
Things to keep in mind
- Judge both ratios together: modest debt with strong coverage is very different from modest debt a shrinking business can no longer service.
- Industry context is everything. A "high" ratio in one sector is routine in another; compare with peers and the company's own past.
- Debt magnifies outcomes in both directions; it is a tool, not a vice or a virtue.
- These ratios use balance-sheet snapshots and one year's profit. Check several years, and remember no ratio is a buy or sell signal.
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