Hong Life CalculatorsUnderstanding the debt-to-equity and interest coverage calculator — concept and principle
The debt-to-equity (D/E) ratio shows how much a company relies on borrowed money compared with its owners' money, and the interest coverage ratio shows how comfortably its operating profit pays the interest on that debt. Lenders, investors and business owners use the pair to judge financial risk: one looks at the balance sheet, the other at the income statement. The calculator works with any currency; the example uses US dollars.
How it is calculated
- Debt-to-equity (%) = total liabilities ÷ shareholders' equity × 100
- Interest coverage (×) = EBIT ÷ interest expense
Total liabilities and shareholders' equity come from the balance sheet. EBIT (earnings before interest and taxes, roughly operating profit) and interest expense come from the income statement for the same period, usually one year.
The principle
Every asset a company owns is funded either by creditors or by owners: assets = liabilities + equity. D/E compares those two sources. Borrowing can raise returns to owners when the business earns more than the cost of debt, but it adds fixed obligations that must be paid even in a bad year. Interest coverage tests that pressure directly: it asks how many times the operating profit could pay this year's interest. Some analysts use only interest-bearing debt in the numerator instead of total liabilities; this calculator uses total liabilities, which gives a broader and higher figure.
Worked example
- Inputs: total liabilities $800,000, equity $1,000,000, EBIT $240,000, interest $40,000.
- D/E: 800,000 ÷ 1,000,000 = 0.80, or 80%.
- Interest coverage: 240,000 ÷ 40,000 = 6×.
The company has 80 cents of liabilities for every dollar of equity, and operating profit covers interest six times.
How to read the result
Normal D/E levels vary widely by industry. Utilities, banks and property firms often run high ratios, while software firms often run low ones, so compare with peers. For interest coverage, a value below 1× means operating profit does not cover interest; values below about 1.5–2× are commonly treated as a warning sign, and higher values indicate more room to absorb a fall in profit. Negative equity makes D/E meaningless, so look at other measures in that case.
Common mistakes
- Mixing book values from different dates or periods.
- Comparing a ratio based on total liabilities with one based only on interest-bearing debt.
- Ignoring lease liabilities or off-balance-sheet obligations.
- Judging coverage from one unusually good or bad year.
Frequently asked questions
Is a D/E ratio of 80% high?
It depends on the industry. For many non-financial firms it is moderate, but compare with companies in the same sector.
Why use EBIT rather than net income for coverage?
Interest is paid before tax, so EBIT shows the profit actually available to pay it.
Is D/E sometimes written as a decimal?
Yes. 80% and 0.8 mean the same ratio.
Sources: Brealey, R. A., Myers, S. C. & Allen, F., Principles of Corporate Finance, McGraw-Hill · CFA Institute, Financial Reporting and Analysis (CFA Program curriculum)