Debt Ratios — How Much Debt Is Too Much? | Finzony India

Academy Fundamental Analysis Financial Ratios — The Language of Stock AnalysisDebt Ratios — How Much Debt Is Too Much?

Lesson 3 of 4

Debt Ratios — How Much Debt Is Too Much?

A profitable company can still go bankrupt if it can't service its debt. These ratios tell you how safe the balance sheet really is.

Why Debt Kills Companies — Even Good Ones

Imagine a restaurant chain making ₹10 Cr profit every year. Sounds great. But if they borrowed ₹100 Cr to expand and now pay ₹12 Cr in interest annually, they're technically losing money. If a recession hits and profits fall to ₹5 Cr, they can't even pay interest — let alone repay principal. This is how profitable-looking businesses collapse.

Debt ratios help you detect this risk before it blows up. They answer three questions: How much debt does the company carry relative to its own funds? Can it comfortably pay interest from its profits? And can it meet short-term obligations? Three ratios cover all three questions.

1. Debt-to-Equity Ratio (D/E)

Formula

D/E = Total Debt ÷ Shareholders' Equity

Total Debt = Long-term borrowings + Short-term borrowings (from balance sheet)

The D/E ratio compares how much the company owes to outsiders (debt) versus how much belongs to shareholders (equity). A D/E of 1x means equal parts debt and equity. A D/E of 0.5x means for every ₹100 of equity, there's only ₹50 of debt — a conservative balance sheet. A D/E of 3x means the company is 3x more leveraged than its equity — risky territory.

D/E = 0

Debt-free

The ideal for most investors. Company funds all operations through internal cash flows. Examples: TCS, Infosys, Nestle India. Zero financial risk from debt.

D/E = 0–0.5x

Conservative

Minimal debt. The company has easily manageable interest obligations. Even a bad year won't threaten financial stability. Very comfortable zone for long-term investors.

D/E = 0.5x–1x

Moderate

Acceptable for most sectors if the business has stable cash flows and high interest coverage. For capital-intensive businesses like real estate or infra, this can be normal.

D/E = 1x–2x

High

Elevated leverage. Only acceptable if the company generates strong and predictable earnings that can easily cover interest. Banks and NBFCs naturally operate at high D/E due to their business model — treat them differently.

D/E > 2x

Danger Zone

Very high debt. A business downturn, rate hike, or demand slump could push the company into default. Requires deep scrutiny. Avoid for most retail investors unless you understand the debt structure in detail.

Sector Exception

Banks and NBFCs (like HDFC Bank, Bajaj Finance) operate with D/E of 8–10x by design — your fixed deposits are their "debt." Never compare a bank's D/E to a manufacturing company. For banks, use different metrics: NIM, NPA ratio, and CASA ratio instead.

2. Interest Coverage Ratio (ICR)

Formula

ICR = EBIT ÷ Interest Expense

EBIT = Earnings Before Interest & Tax (Operating Profit)

D/E tells you how much debt a company has. ICR tells you if the company can actually afford it. An ICR of 3x means the company earns 3 times more operating profit than it pays in interest — comfortable. An ICR of 1.2x means the company barely covers its interest cost. Any earnings dip and it's in trouble.

ICR is arguably more important than D/E for assessing immediate financial risk. You can have high debt but high ICR (safe) or low debt but low ICR (still risky if profits are erratic).

ICR > 5x

Very Safe

Company earns 5x its interest costs. Even a 60–70% profit drop won't threaten debt service. Comfortable for long-term investors.

ICR 2x–5x

Acceptable

Adequate coverage. Company manages debt well under normal conditions. Watch for any sharp profit drops or rising interest rates.

ICR < 1.5x

Danger Zone

Company barely covers interest from operating profit. A single bad quarter, an interest rate hike, or industry headwinds could push it to default.

3. Current Ratio — Short-Term Liquidity

Formula

Current Ratio = Current Assets ÷ Current Liabilities

Current Assets = Cash, receivables, inventory (due within 1 year) | Current Liabilities = Payables, short-term debt (due within 1 year)

This ratio measures if a company can meet its near-term obligations. A current ratio of 2x means for every ₹1 the company owes in the next 12 months, it has ₹2 in liquid assets. A ratio below 1x means the company may struggle to pay its short-term bills — a liquidity crisis waiting to happen.

Current Ratio	Interpretation	Action
> 2x	Strong liquidity — company has ample buffer to meet short-term obligations	Green flag
1x–2x	Adequate. Borderline acceptable — monitor closely if business is cyclical	Acceptable
< 1x	Company owes more short-term than it can cover — potential liquidity stress	Red flag
Very high (5x+)	May indicate idle cash or poor capital allocation — not always good	Investigate

Real Example — Comparing Balance Sheet Safety

Same sector, vastly different risk profiles (illustrative figures):

Company	Sector	D/E	ICR	Current Ratio	Verdict
Infosys	IT	0x	N/A (debt-free)	2.8x	Rock solid
Asian Paints	FMCG	0.1x	60x+	1.9x	Excellent
Tata Steel	Steel	0.8x	4x	1.1x	Manageable
Fictitious Co.	Infra	3.2x	1.1x	0.8x	High risk

* Illustrative. Check Screener.in for actual ratios.

Common Traps When Analysing Debt

Off-balance-sheet debt

Some companies keep debt hidden in subsidiaries, joint ventures, or lease obligations (operating leases). Since Ind AS 116, most operating leases must appear on the balance sheet — but always check notes to accounts for guarantees given to subsidiaries. What looks debt-free on the face of the balance sheet may not be.

Pledging of promoter shares

When promoters pledge their own shares to take personal loans, those shares could be dumped in the market if the stock falls. Always check NSE/BSE disclosures for promoter pledge %. Above 50% pledging is a serious warning sign — even if the company's own D/E looks fine.

Debt taken for growth vs distress

Not all debt is bad. Reliance Industries took on massive debt to build Jio — a strategic bet that paid off spectacularly. Context matters: Is the debt being used to expand capacity or build assets that will generate future cash flows? Or is it being used to cover operating losses? Revenue growth alongside debt growth = expansion. Debt growing while revenue stagnates = distress.

Sector benchmarks differ

Capital-intensive sectors (real estate, infrastructure, steel) routinely carry higher debt than FMCG or IT. Never apply a universal D/E benchmark. A D/E of 1.5x might be conservative for a real estate developer but alarming for a pharma company. Always compare within the same sector and look at the trend over 3–5 years, not a snapshot.

Key Takeaway

Use all three ratios together — D/E for overall leverage, ICR for affordability, and Current Ratio for short-term safety. A strong business ideally has D/E below 0.5x, ICR above 5x, and Current Ratio above 1.5x. If any of these flash red, dig deeper before investing — most corporate failures trace back to debt problems that were visible in the ratios years earlier.

Frequently Asked Questions

Where can I find debt ratios for Indian stocks?

Screener.in shows D/E ratio, Interest Coverage, and Current Ratio directly on the company summary page under "Key Metrics." Tickertape also has them with peer comparison. For more granular data (quarterly debt changes), check the balance sheet tab on Screener.in or the investor relations section on the company's own website.

Is zero debt always best?

Zero debt is excellent from a safety perspective, but a well-managed company with moderate debt (D/E 0.3–0.5x) and high ICR can actually generate better shareholder returns by using cheap debt to fund expansion. The question is not "is there debt?" but "can the company afford it and is it being used productively?" Companies like Bajaj Finance carry significant debt by nature of being a lending business — and that's by design.

What is the difference between long-term and short-term debt?

Long-term debt (bonds, term loans) is due beyond one year — less immediate risk but more interest cost over time. Short-term debt (working capital loans, commercial paper) is due within one year — more dangerous if the company can't roll it over. A company heavily reliant on short-term debt to fund long-term assets is risky — this is "maturity mismatch," a common sign before financial stress.

What happened with companies that had high D/E?

IL&FS, DHFL, and Reliance Capital are textbook examples from the Indian market. All three had D/E ratios that were warning signs for years before they defaulted. IL&FS's debt was hidden across hundreds of subsidiaries. Screener.in's 5-year trend view on debt would have shown the problem clearly for all three — emphasising why tracking ratios over time matters as much as current values.

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