Fundamental Analysis · Intermediate · 5 min
Debt and equity ratio
You can calculate the equity ratio, debt-to-equity ratio, net debt to EBITDA and interest coverage, and explain why debt raises both returns and risk.
Debt cuts both ways
In trading, leverage lets a small move produce a large result, in both directions. Companies have the same tool: debt.
A company that borrows to build a factory keeps all the extra profit for its shareholders once the interest is paid. In a bad year, though, the interest is still due. Many company failures start not with a bad product but with too much debt at the wrong moment. A few ratios show how much a company has borrowed and how comfortably it can carry it.
Who paid for the assets?
Every asset on the balance sheet was paid for by someone: by the shareholders (equity) or by others (liabilities). For the fictional bicycle maker:
Four common measures:
- The equity ratio is equity divided by total assets: 320 ÷ 800 = 40%. The higher it is, the more of the company the owners financed themselves.
- The debt-to-equity ratio compares debt with equity. Definitions vary: some use only borrowings (200 ÷ 320 = 0.63), some all liabilities (480 ÷ 320 = 1.5). Always check which.
- Net debt is borrowings minus cash. With 60 million in cash, it is 140 million. Divided by EBITDA of 100 million, it gives 1.4: roughly how many years of EBITDA the debt represents.
- The interest coverage ratio divides EBIT by interest: 80 ÷ 10 = 8. Operating profit could fall by more than 80% before it no longer covered the interest.
Lenders often write limits on such ratios into loan contracts. If a company breaks one, the loan can become due early or more expensive.
Why borrow at all? Interest is usually cheaper than what shareholders expect to earn, and in many countries it is tax-deductible, within limits. Moderate debt can raise the return on equity. Too much debt turns a bad year into a crisis.
Normal depends on the business
What counts as "a lot of debt" depends on the industry. According to Aswath Damodaran's data for US companies as of January 2026:
General utilities carried debt of about 6.8 times EBITDA, software companies about 1.7 times. Interest coverage was about 2.6 for utilities and about 19 for software.
That does not make utilities reckless. Their income is steady and often regulated, so lenders accept more debt. Software companies need few physical assets and often fund themselves from their own cash. Banks are a special case: they are financed mostly by deposits and borrowing by design, so their equity ratios are far lower and not comparable with industrial companies.
Compare a company with its own industry and its own history.
Common mistakes
- Comparing debt ratios across industries. A normal level for a utility would be alarming for a software company.
- Mixing definitions. Debt-to-equity can mean borrowings or all liabilities. The results can differ by a factor of two or more.
- Ignoring when debt falls due. A large loan that must be refinanced next year is a bigger risk when interest rates are high.
- Forgetting lease obligations. Long rental contracts work much like debt and have appeared on the balance sheet since the IFRS 16 and US lease rules took effect in 2019.
The takeaway
Debt ratios show how much of a company is financed by borrowing and how easily it can pay its interest. Debt magnifies both good and bad years.
Check yourself
Quick quiz
4 questions. Instant feedback, nothing is saved.
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1Tap the part of the funding that belongs to the shareholders.
Tap the chart.
Equity of 320 million out of 800 million gives an equity ratio of 40%.
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2A company has borrowings of 300 million, cash of 100 million and EBITDA of 80 million. What is its net debt to EBITDA?
Net debt = 300 − 100 = 200 million. 200 ÷ 80 = 2.5: it would take about two and a half years of EBITDA to repay it.
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3EBIT is 40 million and interest is 20 million. What does an interest coverage of 2 suggest?
Coverage = EBIT ÷ interest = 2. If EBIT halved to 20 million, all of it would go to interest.
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4Why can't you compare a utility's debt ratios directly with a software company's?
Normal debt levels depend on how stable a business's income is and how much it must invest.
of 4 correct.