Debt and coverage ratios: how much is owed, and can the profit carry it
Borrowing multiplies the owners' returns when things go well and multiplies the strain when they do not. Debt-to-equity shows how much of the business is funded by lenders, and interest cover shows how comfortably the profit pays them. This lesson stress-tests a company in the calculator, then reads Titan's rising debt and Info Edge's almost none.
- Level
- Beginner
- Reading time
- About 25 minutes
- Know this first
- Profitability ratios
By the end you will be able to:
- work out debt to equity, the debt ratio, the equity ratio and interest cover
- explain why the answer depends on what is counted as debt
- stress-test a company by cutting its profit and recomputing the cover
- tell borrowings from other liabilities such as deferred tax and deferred revenue
Why lenders change the picture
A business can be funded by its owners' money, by borrowed money, or by a mix. The previous lesson showed what the mix does to the owners' return: in the calculator, the same operating profit gave a return on equity of 15.0% with no debt and 45.0% with ₹8,00,000 of it. Borrowing is attractive when the business earns more than the loan costs. It also adds a claim that has to be met whatever the year brings. Interest is due even when profit falls, and a lender who is not paid can force the issue, which a shareholder cannot.
Two questions follow, and two groups of ratios answer them. How much is borrowed? The balance sheet ratios answer that. Can the profit carry it? Interest cover answers that, using the income statement. They are called solvency ratios, because they ask whether the business can survive its obligations over the long run, which is a different question from the liquidity of the last lesson.
The ratios
- Debt to equity = debt ÷ equity. How many rupees of borrowing for each rupee the owners have in the business. What counts as "debt" is the main decision, and the lesson comes back to it below.
- Total liabilities to equity = total liabilities ÷ equity. The widest version: everything the company owes, not only borrowings.
- Debt ratio = total liabilities ÷ total assets. The share of the assets that is owed to someone.
- Equity ratio = equity ÷ total assets. The share that belongs to the owners. The debt ratio and the equity ratio always add up to 100%, since assets equal liabilities plus equity.
- Interest cover = operating profit ÷ finance costs. How many times the profit before interest could pay the interest. It is also called times interest earned.
Stress-test a company
A company is funded by ₹6,00,000 of equity and the amount of debt you choose, at 10% interest. You also choose its operating profit. The third slider cuts that profit by a percentage, as if the next year went badly, and the ledger recomputes the cover. The left page shows the interest and what is left after it, once the profit has fallen, and the right page shows the ratios.
Debt is 0.67 times equity and 40.0% of the money in the business. Operating profit covers interest 7.5 times. If profit falls 30%, cover is still 5.3 times and ₹1,70,000 is left after interest.
Three experiments. First, raise debt to ₹10,00,000 and keep the rest. Interest rises to ₹1,00,000 and cover falls from 7.5 to 3.0 times, and a 30% fall in profit takes it to 2.1. Second, with debt at ₹10,00,000, push the fall to 60%. Cover is 1.2, and only ₹20,000 is left after interest. A company with that little room is one bad quarter away from borrowing to pay interest. Third, lower operating profit to ₹1,00,000 with debt of ₹6,00,000 and raise the fall to 50%: the profit no longer pays the interest, and the ledger shows how much is short. The same debt that looked comfortable in a good year is a problem in a bad one, which is why cover is read together with how steady the profit is.
What counts as debt?
The first decision in any debt ratio is what goes on the top. Three choices are common, and each gives a different answer for the same company.
- Borrowings only. The balance sheet lines for loans, debentures and similar, both long-term and those falling due within a year.
- Borrowings and lease liabilities. Since the accounting for leases changed, the obligation to pay rent on leased shops and offices sits on the balance sheet as a liability. Many analysts count it as a borrowing, because it is a fixed payment that has to be met.
- Everything owed. Total liabilities, which add trade payables, tax liabilities and the rest. This is a wider measure of what the company owes, and it is not only debt in the lending sense.
Which is right depends on the question. A lender asks about borrowings. An analyst of fixed costs adds leases. A creditor asks about everything. State the choice, or the number cannot be compared.
The figures behind the ratios
Titan is in ₹ crore and Info Edge in ₹ million, as printed. Titan's borrowings and gold on loan are separate lines on its balance sheet. Operating profit is revenue less every cost except finance costs, as in the previous lessons.
| Figure | Titan FY2023-24, ₹ crore | Titan FY2022-23, ₹ crore | Info Edge FY2023-24, ₹ million | Info Edge FY2022-23, ₹ million |
|---|---|---|---|---|
| Borrowings, non-current | 3,139 | 0 | 12.65 | 12.66 |
| Borrowings, current | 2,670 | 1,190 | 12.57 | 8.51 |
| Lease liabilities, non-current and current | 1,914 | 1,582 | 2,208.91 | 854.76 |
| Gold on loan | 4,938 | 5,090 | n/a | n/a |
| Total liabilities | 18,405 | 13,094 | 40,585.03 | 19,877.08 |
| Equity | 14,457 | 11,994 | 254,763.15 | 109,264.82 |
| Operating profit | 4,577 | 4,406 | 8,875.23 | 7,394.74 |
| Finance costs | 480 | 240 | 163.11 | 38.89 |
The ratios for both companies
| Ratio | Titan FY2023-24 | Titan FY2022-23 | Info Edge FY2023-24 | Info Edge FY2022-23 |
|---|---|---|---|---|
| Debt to equity, borrowings only: (non-current + current borrowings) ÷ equity | 0.40 | 0.10 | 0.0001 | 0.0002 |
| Debt to equity, borrowings and lease liabilities | 0.53 | 0.23 | 0.01 | 0.01 |
| Debt to equity, borrowings, gold on loan and lease liabilities (an illustration) | 0.88 | 0.66 | n/a | n/a |
| Total liabilities ÷ equity | 1.27 | 1.09 | 0.16 | 0.18 |
| Debt ratio: total liabilities ÷ total assets | 56.0% | 52.2% | 13.7% | 15.4% |
| Equity ratio: equity ÷ total assets | 44.0% | 47.8% | 86.3% | 84.6% |
| Interest cover: operating profit ÷ finance costs | 9.5 times | 18.4 times | 54.4 times | 190.1 times |
Titan: borrowing up, cover halved
At 31 March 2023 Titan's borrowings were ₹1,190 crore, all of them current. A year later they were ₹5,809 crore: ₹3,139 crore of new long-term borrowing and an extra ₹1,480 crore of short-term, both visible as lines in its cash flow statement. Debt to equity moved from 0.10 to 0.40. Equity grew too, but not as fast. Counting lease liabilities and gold on loan as well, the figure goes from 0.66 to 0.88, a smaller rise because gold on loan, ₹4,938 crore, fell slightly from ₹5,090 crore and so cushioned the increase. The widest measures moved less: total liabilities to equity went from 1.09 to 1.27, and the debt ratio from 52.2% to 56.0%, with the equity ratio falling from 47.8% to 44.0%.
Interest cover shows the effect of that borrowing on the income statement. Finance costs doubled, from ₹240 crore to ₹480 crore, while operating profit rose only 3.9%, so cover went from 18.4 times to 9.5 times. A cover of 9.5 is comfortable in the sense that the profit would still pay the interest if it halved, which would leave about 4.8 times. But the trend, with debt up and cover halving in a single year, is worth watching, and it came with a purpose. The cash flow statement shows ₹4,726 crore invested in subsidiaries and other equity instruments in the same year. Borrowing to buy a stake in another business is a bet that the stake will earn more than the loan costs, and any earning from it arrives as dividends or in the group's consolidated profit, not in standalone operating profit. This lesson does not judge the bet. It shows where the debt came from.
The lesson on profitability ratios pointed out that gold on loan can be read as a supplier balance or as short-term debt. The table shows how much it matters: the debt to equity ratio is 0.40 on borrowings alone, 0.74 once gold on loan is counted, and 0.88 with leases too. Titan's finance costs line is printed as one figure, and this lesson does not split it between bank borrowing, gold on loan and leases.
Info Edge: almost no borrowing, but plenty of liabilities
Info Edge's borrowings were only ₹25.22 million at 31 March 2024, against equity of ₹254,763.15 million, so debt to equity is 0.0001, effectively zero. Counting lease liabilities of ₹2,208.91 million it is still only 0.009. Interest cover is 54.4 times, and 190.1 times a year earlier. Finance costs of ₹163.11 million, against ₹38.89 million the year before, cannot be interest on the year-end borrowings of ₹25.22 million, which are far too small to produce it. The notes to the accounts would show how the cost divides, and the lease liabilities are one candidate.
Yet total liabilities are ₹40,585.03 million, which is 0.16 times equity and 13.7% of the assets. Look at what they are. A deferred tax liability of ₹24,319.72 million makes up 60% of the total. It is tax that will be payable on the investment gains if the investments are sold, as the lesson on the balance sheet explained. Deferred revenue of about ₹11,360 million, from the earnings presentation, is another 28%: services paid for and not yet delivered. Neither is a loan. The company owes far more than its borrowings suggest, and almost none of it is owed to lenders. That is why you need to look inside the total.
What these ratios cannot tell you
- Debt ratios look at one day. Debt can be repaid or raised the week after the balance sheet date.
- Cover uses one year of profit. A cyclical business can have excellent cover in a good year and none in a bad one, as the calculator showed.
- Interest is not the only payment. Cover ignores the repayment of principal, which also has to be found. A loan that falls due next year may need refinancing whatever the cover.
- Operating profit is not cash. A company can show good cover and still lack the cash to pay, for the reasons in the lessons on cash flow. Some lenders use cash-based measures for that reason.
- The cheapest funding is not always the safest. Short-term borrowing can cost less than long-term, but it has to be renewed. Check when debt falls due.
- Industry norms differ. A utility with steady income can carry far more debt than a business whose profit swings.
How much do three global companies borrow?
The table counts only borrowings: for Apple the commercial paper and term debt, for Microsoft its short-term and long-term debt, and for Toyota all of its short-term and long-term debt. It leaves out lease liabilities and operating obligations such as payables, so the comparison is on borrowed money in the strict sense. The last column sets cash and investments against that borrowing.
| Latest balance sheet, millions | Borrowings | Borrowings over equity | Liabilities over assets | Cash and investments less borrowings |
|---|---|---|---|---|
| Apple | $98,657 | 1.34 | 79.5% | $33,763 |
| Microsoft | $43,151 | 0.13 | 44.5% | $51,414 |
| Toyota | ¥38,792,879 | 1.05 | 60.6% | ¥(29,810,475) |
Apple owes the most relative to its equity, 1.34 times, and Microsoft the least, 0.13 times. Apple's equity is small because it has bought back so much stock, and the more informative sign is that it holds more cash and investments than debt, a net surplus of $33,763 million. Microsoft's surplus is $51,414 million. Both would be able to repay all borrowings from liquid assets. Compare the share of assets funded by all liabilities, 79.5% at Apple, 44.5% at Microsoft and 60.6% at Toyota, and the picture is different, because liabilities include supplier credit and prepayments as well as loans.
Toyota: borrowing against loans it has made
Toyota's borrowings are ¥38,792,879 million, 1.05 times its equity, and exceed its cash by ¥29,810,475 million. Read alone, that sounds like a heavily indebted company. The assets side explains why it is not what it seems: ¥33,625,035 million of the balance sheet is receivables from its financial services business, which is lending to car buyers and dealers and is funded by borrowing. If those receivables are set against the borrowing, the remaining borrowing is ¥5,167,844 million, which is less than the ¥8,982,404 million of cash it holds, leaving ¥3,814,560 million in net cash. This is a rough adjustment because the receivables are not a perfect match for the debt, but it shows how the same facts can read as high leverage or modest leverage depending on whether the finance arm is treated as separate.
The cost of borrowing is the other half of the picture. Toyota's cash flow statement shows interest paid of ¥1,609,083 million, which is 33.6% of its operating income of ¥4,795,586 million. A standard coverage ratio uses the income statement's interest expense, and the summary statements used here do not give a clean figure for it for any of the three companies, so a coverage ratio calculated from the annual reports' notes would be the next step for a full analysis.
Leases and the rulebook
Whether leases count as debt depends on the accounting. Under IFRS 16 a lessee uses one model for nearly all leases: a liability and an asset on the balance sheet, with depreciation and interest in the income statement. Under US GAAP's ASC 842 the liability also appears, but operating leases keep a single straight-line lease cost in the income statement and finance leases follow the IFRS pattern. The consequence for coverage is that the same lease makes operating profit higher under IFRS, because only depreciation is deducted above it, while the interest part sits lower down. To compare leverage across the two systems, decide in advance whether to treat lease liabilities as debt for every company and then do so for all of them.
Common mistakes
Calling all liabilities "debt"
Info Edge owes ₹40,585.03 million and borrows ₹25.22 million. The two measure different things, and a lender, a tax authority and a customer each have different claims.
Comparing debt-to-equity figures built on different definitions
Titan's ratio is 0.40, 0.53 or 0.88 depending on what is counted. Always check the definition behind a quoted figure.
Reading a high ratio as automatically bad
A business with steady profit and strong cover can carry more debt. The ratio asks for a closer look and does not settle the matter.
Reading cover on its own
Titan's 9.5 times looks comfortable, but together with the doubling of finance costs and the rise in borrowings it tells a story of change. Read the trend.
Forgetting equity changes too
Debt to equity can rise because debt rose or because equity fell. Check which.
Try it yourself
1. A company has borrowings of ₹40 lakh, total liabilities of ₹60 lakh and equity of ₹80 lakh. Work out debt to equity, the debt ratio and the equity ratio.
Show the working
Debt to equity = 40 ÷ 80 = 0.50. Total assets = 60 + 80 = 140. Debt ratio = 60 ÷ 140 = 42.9%. Equity ratio = 80 ÷ 140 = 57.1%. The last two add up to 100%.
2. A company has operating profit of ₹12 lakh and interest of ₹4 lakh. Work out the cover. By what share can profit fall before it no longer pays the interest?
Show the working
Cover = 12 ÷ 4 = 3.0 times. Profit can fall to ₹4 lakh before it equals the interest, a fall of 8 ÷ 12 = 67%. Beyond that the interest is not covered.
3. Titan's operating profit grew only 3.9% in FY2023-24, yet its interest cover nearly halved, from 18.4 to 9.5. Explain.
Show the working
Finance costs doubled, from ₹240 crore to ₹480 crore, because borrowings rose from ₹1,190 crore to ₹5,809 crore. The top of the ratio barely changed and the bottom doubled.
4. Info Edge's debt to equity is 0.0001, but its total liabilities are 0.16 times its equity. How can both be true?
Show the working
Borrowings are tiny, ₹25.22 million. Most liabilities are other things: a deferred tax liability of ₹24,319.72 million on investment gains and customers' advance payments recorded as deferred revenue. They are real obligations, but they are not loans.
Where this is used
- A bank sets limits on debt to equity and on interest cover in loan agreements, and tests them every quarter or year.
- A credit rating agency builds its view of a company from cover, debt compared with earnings and the maturity of the debt.
- An investor in a leveraged company watches cover closely, since a small fall in profit changes the owners' position a great deal.
- A finance manager chooses the mix of debt and equity for a new project by looking at what cover each option leaves.
Key terms
- Leverage (gearing)
- The use of borrowed money to fund a business.
- Debt to equity
- Debt divided by shareholders' equity. What counts as debt must be stated.
- Debt ratio
- Total liabilities divided by total assets.
- Equity ratio
- Equity divided by total assets. It and the debt ratio add up to 100%.
- Interest cover
- Operating profit divided by finance costs. Also called times interest earned.
- Solvency
- A company's ability to meet its obligations over the long run.
- Lease liability
- The balance sheet obligation to pay for the use of a leased asset.
- Deferred tax liability
- Tax that will become payable in the future on gains or timing differences already recorded.
Questions people ask
What is a good debt-to-equity ratio?
No single figure is good for every business. Steady businesses with strong cover carry more, and volatile ones need less. Compare with similar firms and with the company's own history, and always check the definition.
What interest cover is safe?
Textbooks often mention a few times, but the right level depends on how steady the profit is. The stress test in this lesson is a better guide: ask what happens to the cover if profit falls by a third or by a half.
Is no debt always better?
Not necessarily. A company with no debt is safe from lenders, but it has not used cheap money to raise the owners' return. Whether that is wise depends on the business.
Should lease liabilities count as debt?
Many analysts count them, because they are fixed payments that have to be met. Others keep them separate. Say which you use.
Sources and review
- Titan Company Limited, audited standalone and consolidated financial results for the year ended 31 March 2024, filed with BSE. Source of the balance sheet and income statement figures.
- Titan Company Limited, audited results with statements of cash flows for the year ended 31 March 2024, filed with BSE. Source of the borrowing, investment and finance cost lines in the cash flow statement.
- Info Edge (India) Limited, audited standalone financial statements, Q4 FY24. Source of every Info Edge figure.
- Info Edge (India) Limited, investor presentation, May 2024. Source of deferred revenue.
- CRISIL Ratings, rating rationale for Titan Company Limited, September 2024, for the treatment of gold on loan as short-term debt in credit analysis.
- CPA British Columbia, Financial ratio analysis (guidance), for solvency ratios and the debt-to-equity ratio.
- Apple Inc., Form 8-K, Exhibit 99.1: fourth quarter and full-year fiscal 2025 results, filed with the US Securities and Exchange Commission. Source of Apple's statements.
- Microsoft Corporation, Form 8-K, Exhibit 99.1: fourth quarter and fiscal year 2025 results, filed with the US Securities and Exchange Commission. Source of Microsoft's statements.
- Toyota Motor Corporation, FY2025 Financial Summary (IFRS, unaudited, in millions of yen), furnished to the US Securities and Exchange Commission on Form 6-K. Source of Toyota's statements.
- Deloitte, Roadmap: IFRS and US GAAP comparison, 5.7 Leases, for lessee accounting under IFRS 16 and ASC 842.
How the numbers were checked: both balance sheets were rebuilt from the printed lines and every total matched, including the check that liabilities plus equity equal assets. Titan's new long-term borrowing and the rise in short-term borrowing were matched to the balance sheet change and to the cash flow statement, and finance costs paid in the cash flow statement equal the finance costs expense. Each ratio was recomputed in code. The calculator was tested against separate arithmetic across thousands of slider combinations.