Solvency Ratios
Solvency and Debt Service Ratios
This lesson reads Debt-Equity, Debt to Assets, Interest Coverage, DSCR, and Net Debt to EBITDA as one debt-risk story.
Concept First
Learn It Step By Step
Start with the business meaning, then move into the formula.
How should I read Debt-Equity Ratio?
Debt-Equity compares lender funding with owner funding. If Company A has debt of Rs. 100 and equity of Rs. 100, Debt-Equity is 1.0x. Company B has debt of Rs. 200 and equity of Rs. 100, so it is 2.0x. B has higher financial risk because lenders have a larger claim relative to owners. Lower is generally safer, but some stable infrastructure or utility businesses can carry more debt than volatile businesses.
How should I read Debt to Assets?
Debt to Assets shows what portion of the asset base is funded by borrowing. If assets are Rs. 500 and debt is Rs. 150, the ratio is 30%. If debt is Rs. 300, it is 60%. Lower usually means a stronger cushion, but the ratio must be read with asset quality. Debt secured by productive assets with stable cash flows is different from debt funding losses.
How should I read Interest Coverage?
Interest Coverage asks whether operating profit can pay interest. If EBIT is Rs. 120 and interest is Rs. 30, coverage is 4.0x. If interest is Rs. 80, coverage is only 1.5x. Higher is better because the company has more room before lenders become uncomfortable. A low ratio is especially risky in cyclical businesses where EBIT can fall quickly.
How should I read DSCR?
DSCR is stricter because loans require principal repayment as well as interest. If cash available for debt service is Rs. 150 and principal plus interest due is Rs. 100, DSCR is 1.5x. If dues are Rs. 170, DSCR is 0.88x. Higher is better. Below 1.0x means the company cannot meet scheduled debt service from available cash without support, refinancing, or delay.
How should I read Net Debt to EBITDA?
Net Debt to EBITDA gives a rough repayment multiple. If debt is Rs. 500, cash is Rs. 100, and EBITDA is Rs. 200, net debt is Rs. 400 and the ratio is 2.0x. If EBITDA is only Rs. 100, the ratio becomes 4.0x. Lower is usually safer because operating earnings can repay debt faster, but EBITDA must be checked against capex and working-capital needs.
Formula Lab
Understand the Formula
Read the formula like a business sentence before calculating it.
Formula 1
Debt-Equity = Total Debt / Shareholders' Equity
Formula 2
Debt to Assets = Total Debt / Total Assets
Formula 3
Interest Coverage = EBIT / Interest Expense
Formula 4
DSCR = Cash Available for Debt Service / Principal plus Interest Due
Formula 5
Net Debt to EBITDA = (Debt - Cash) / EBITDA
Solved Case Study
Read the Numbers Like an Analyst
Work through one business case slowly: understand the situation, calculate the ratios, then interpret what the numbers are really saying.
Case context
A Hyderabad infrastructure company has debt Rs. 600L, equity Rs. 400L, total assets Rs. 1,500L, cash Rs. 100L, EBITDA Rs. 250L, EBIT Rs. 180L, interest Rs. 60L, and principal due Rs. 90L. Debt-Equity is 1.5x, Debt to Assets is 40 percent, Interest Coverage is 3.0x, DSCR is 1.67x if cash available is Rs. 250L, and Net Debt to EBITDA is 2.0x.
Case: Two companies with similar assets
Company A has debt of Rs. 300L, equity of Rs. 500L, total assets of Rs. 900L, cash of Rs. 50L, EBITDA of Rs. 220L, EBIT of Rs. 160L, interest of Rs. 40L, and principal due of Rs. 60L. Company B has debt of Rs. 600L, equity of Rs. 300L, total assets of Rs. 900L, cash of Rs. 50L, EBITDA of Rs. 180L, EBIT of Rs. 110L, interest of Rs. 70L, and principal due of Rs. 90L.
Measure leverage first
Debt-Equity and Debt to Assets show how much lender funding sits in the capital structure.
B is more leveraged. Lenders fund a much larger share of the business.
Test interest comfort
Interest Coverage asks whether operating profit can pay annual interest.
A has a much larger safety cushion. B has little room if EBIT falls.
Test total debt service
DSCR includes principal repayment as well as interest. Net Debt to EBITDA gives a rough repayment multiple.
A is safer. B may survive in a good year, but has far less room for a downturn, delayed collections, or refinancing pressure.
Interpretation
What This Means In Practice
Read the result as a business signal, not as a standalone number.
How to read this
Solvency analysis asks whether the capital structure is safe. Debt-Equity and Debt to Assets show how much borrowing funds the business. Interest Coverage asks whether operating profit can pay interest. DSCR asks whether cash can cover principal and interest. Net Debt to EBITDA gives a rough repayment multiple using operating earnings. Start with the business meaning, then check the trend, peer benchmark, source line items, and cash impact.
What to remember
Debt is not bad by itself. Debt becomes dangerous when cash flows are volatile, coverage is thin, refinancing is uncertain, or borrowings fund losses instead of productive assets.
Key Takeaway
Debt is not bad by itself. Debt becomes dangerous when cash flows are volatile, coverage is thin, refinancing is uncertain, or borrowings fund losses instead of productive assets.
Practice Checkpoint
Check Your Understanding
Work through the quiz in smaller sets. Your answers stay visible while this page is open, so you can review before moving on.
Question 1 of 25
Level 1What does Debt-Equity Ratio compare?
Question 2 of 25
Level 1What does Interest Coverage test?
Question 3 of 25
Level 1Why is DSCR stricter than Interest Coverage?
Question 4 of 25
Level 1What does Net Debt mean?
Question 5 of 25
Level 2Debt is Rs. 600L and equity is Rs. 400L. What is Debt-Equity Ratio?
20 questions remaining in this lesson.
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Knowledge Path
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EBITDA
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