Solvency ratios

Liquidity is the twelve-month question. Solvency is the permanent one. Can the capital structure survive a full cycle? You'll get three stock measures here, then the flow measures in the coverage ratios.

What counts as debt in the debt-to-equity ratio?

Decide what "debt" means before you divide. Two conventions for debt-to-equity coexist, and mixing them across companies is the most common leverage error:

• D/E (financial) = (borrowings + lease liabilities) ÷ total equity: the analyst's default. Debt here means interest-bearing contractual claims: bonds, loans, commercial paper, current maturities and, as the liabilities work showed, capitalized lease liabilities. Those are borrowing in substance under IFRS 16/Ind AS 116 and ASC 842 alike.
• Liabilities/equity = total liabilities ÷ equity: sometimes quoted, but it drags in payables and deferred revenue, plus provisions. Those are operating items. A SaaS company with huge deferred revenue isn't "leveraged."

State your convention, apply it the same way to every company you compare, and include leases. A close relative, debt-to-capital, is Debt ÷ (Debt + Equity). It rescales the same information onto 0 to 100%.

You already know Financial leverage = average total assets ÷ average total equity from DuPont. That multiplier is the third DuPont lever, the one that turns a 7.5% ROA into a 24% ROE at 3.2× leverage. It also needs a warning label. The multiplier amplifies both directions, and unlike margin and turnover, any board can dial it up in a quarter. High-ROE screens are full of ordinary businesses on extraordinary leverage. You catch them by putting DuPont next to the coverage ratios.

Should you use gross debt or net debt?

Gross vs net debt. Net debt = total debt − cash − liquid investments. Cash could repay debt tomorrow, so the net claim is what matters. That's usually true, but two real cautions apply.

• Apple (illustrative, ~FY24 scale): gross debt ~$105bn against cash and marketable securities of ~$155bn, so net cash of ~$50bn. Why borrow at all with $155bn in the bank? For years much of that cash was held in foreign subsidiaries, and bringing it home triggered US tax. Borrowing against it to fund buybacks was cheaper. The 2017 TCJA transition tax largely resolved that, but the cheap, laddered debt raised in that era is still there. So gross debt is the obligation, while net debt assumes the cash is free to meet it. Ask where the cash lives and what it's for.
• InterGlobe Aviation / IndiGo (illustrative, ~FY24 scale): total debt ~₹52,000 cr against reported cash and investments of ~₹35,000 cr. Of that debt, ~₹48,000 cr is capitalized aircraft leases. Naive net debt comes to ₹17,000 cr. But IndiGo's own disclosure splits that cash into free (~₹21,000 cr) and restricted (~₹14,000 cr of deposits pledged to lessors and banks). Net debt against free cash only is ₹31,000 cr, nearly double the naive figure. Only ever net cash that can actually move. Restricted balances don't count, and neither does escrowed project cash, such as RERA accounts for Indian developers or DSRA balances in infra SPVs. A working minimum for operations doesn't count either.

What is a good net debt to EBITDA ratio?

Net debt/EBITDA, the credit market's yardstick. Net debt ÷ EBITDA answers one question: how many years of pre-capex operating cash earnings would it take to repay the debt? Lenders write covenants on it and rating agencies anchor to it. Acquirers quote it too. Here are rules of thumb for a normal industrial, to be calibrated by sector and treated as analyst heuristics, never as laws:

How stable EBITDA is sets the tolerance. Regulated utilities and telecom towers live safely at 3 to 5×. A steel company at 3× at the top of the cycle is a time bomb, because the denominator halves in a downturn while the numerator doesn't. The commodities module comes back to this with a mid-cycle lens.

Keep two consistency rules in mind. (1) If the debt includes lease liabilities, and it should, the EBITDA has to be lease-inflated to match. An IFRS 16/Ind AS 116 EBITDA with lease-inclusive debt is consistent. Adding leases to debt while using a rent-deducted US GAAP EBITDA double-counts, the same lease trap you met in lease accounting. (2) EBITDA is only a proxy for cash operating earnings. It ignores capex and taxes as well as working capital. That gap is the reason the coverage family and the cash-flow work both exist.

Does promoter pledging count as leverage?

A company can be conservatively financed while its promoter has pledged 60% of their shares to fund other ventures. Promoter pledging is leverage kept outside the balance sheet, and it can still detonate the stock. The lender invokes the pledge. That forces selling, and the falling price sets off a collateral spiral. On BSE/NSE, the shareholding-pattern disclosure shows pledge percentages every quarter. Note it now as part of the leverage picture. Later, the forensic weeks treat it fully as a red flag.