If you want to master company debt analysis, avoid the classic beginner investing mistakes, and finally understand corporate leverage ratios without needing a finance degree or a therapist, then buckle up — because this is the article that is going to change the way you look at every balance sheet you ever encounter.

I am a trader. I have stared at spreadsheets so long that sometimes I see debt-to-equity ratios in my sleep. I once had a dream that I was drowning in a sea of interest coverage ratios and a little boat floated by with the number 1.5 painted on the side. I woke up sweating. That is not normal. Do not let that be you.

But here is the beautiful truth: understanding a company’s debt does not have to be complicated. You do not need a Bloomberg terminal, a Wharton MBA, or a contact at Goldman Sachs who picks up on the first ring. You just need a few key numbers, a bit of context, and the willingness to actually look at what a company owes before you hand over your money.

Think about it this way. If you were going to lend your cousin a hundred quid, you would want to know whether he already owes fifty people money before you opened your wallet. Investing in a company is no different. Except the cousin is a multinational corporation, and instead of a hundred quid, it might be your entire retirement fund. No pressure.

This article is going to walk you through the simple method of company debt analysis that beginner investors can actually use. We are going to cover the key ratios, how to read them, what to watch out for, and we will look at real case studies where ignoring debt led to catastrophic outcomes. We will reference peer-reviewed financial research along the way so that you know this is not just a trader talking from vibes — although the vibes are also excellent.

By the end of this, you will be equipped to look at any company’s balance sheet, assess its debt situation, and make a far more informed investment decision. And maybe, just maybe, you will sleep better than I do.

Section 1: What Is Company Debt and Why Does It Matter to Investors?

The Basic Concept — Debt Is Not Automatically Bad

Let us start with the fundamentals. When a company borrows money — whether through bank loans, bonds, or lines of credit — that is debt. And before you panic, not all debt is bad. In fact, debt used intelligently can supercharge a company’s returns, fund expansion, and create enormous shareholder value.

Think of it like this: if you borrow money at 5% interest and invest it in something returning 20%, you are a genius. If you borrow money at 15% interest and invest it in something returning 3%, you are my cousin Derek, and someone needs to have a serious conversation with you.

The academic literature is clear on this. As documented in research by Arhinful and Radmehr (2023) published in SAGE Open, the relationship between financial leverage and company performance is nuanced — coverage ratios and the company’s ability to service debt from operating earnings are far more telling than the existence of debt alone. See: Arhinful & Radmehr, SAGE Open, 2023.

The problem is not that companies have debt. The problem is when companies have too much debt, the wrong kind of debt, or debt that their cash flows cannot realistically service. That is when things go spectacularly wrong. And by spectacularly, I mean the kind of wrong that makes financial history textbooks and sad documentaries.

Debt vs. Equity: The Capital Structure Question

Every company finances itself through some combination of debt and equity. Equity is the money investors put in; debt is the money lenders put in. The mix of these two is called the company’s capital structure, and it has a massive impact on risk and return.

Debt is cheaper than equity because interest payments are tax-deductible and lenders get paid before shareholders if things go wrong. That is why companies like using it. But that same priority arrangement — where lenders get paid first — is also exactly why too much debt is so dangerous for equity investors. If there is nothing left after the debt is serviced, shareholders get nothing. Absolutely nothing. Which is a vibe.

Key principle: Debt amplifies both gains and losses. A highly leveraged company that does well gives you excellent returns. A highly leveraged company that hits turbulence can wipe you out. Always understand the leverage before you invest.

Research from the National Bureau of Economic Research (NBER Working Paper No. 23310) examining data from 40 countries between 1990 and 2014 found a significant negative relationship between excessive government and corporate debt accumulation and broader economic stability — illustrating that unchecked leverage at any level carries systemic risk. See: NBER Working Paper No. 23310.

Section 2: The Key Debt Ratios — Your Cheat Sheet (You Are Welcome)

Now we get to the good stuff. There are five key ratios that any beginner investor needs to understand when analysing a company’s debt. I am going to explain each one as clearly as humanly possible. If after reading this you still do not understand them, I am not sure what to tell you. Maybe try reading it again. Maybe try reading it twice. If you try a third time and still nothing, perhaps finance is not your calling, and that is perfectly okay.

Ratio 1: The Debt-to-Equity Ratio (D/E)

Formula: Total Debt ÷ Total Shareholders’ Equity

This is the big one. The Debt-to-Equity ratio tells you how much debt a company is using relative to its own equity. A ratio of 1.0 means the company has equal amounts of debt and equity. A ratio of 0.5 means it uses half as much debt as equity — relatively conservative. A ratio of 5.0 means the company is swimming in borrowed money, and you should be asking some serious questions.

According to the Corporate Finance Institute, if a business has total assets worth $100 million, total debt of $45 million, and total equity of $55 million, the debt-to-equity ratio is 0.82 — meaning equity makes up the majority of the firm’s assets. See: Corporate Finance Institute — Leverage Ratios.

Now, here is the critical nuance that every beginner misses: context is everything. A D/E ratio of 2.0 might be completely normal in the utilities sector, where companies routinely borrow heavily to fund infrastructure. That same ratio in a tech startup with no physical assets and lumpy revenue would have me backing slowly towards the exit while maintaining eye contact.

Fun trader confession: I once got excited about a company with a D/E of 0.2 and thought I had found a hidden gem with no debt. Turns out they had structured their financing so creatively that the real liabilities were hidden in the footnotes. This is a story about reading footnotes. Please read the footnotes. I beg you.

Ratio 2: The Debt-to-EBITDA Ratio

Formula: Total Debt ÷ EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation)

If the D/E ratio tells you how much debt a company has relative to its equity, the Debt-to-EBITDA ratio tells you how long it would take the company to pay off all its debt using its operating earnings — assuming it dedicated all of them to that purpose. Which, for the record, no company does. But it is a useful thought experiment.

Generally speaking, a Debt-to-EBITDA below 2x is considered conservative, between 2x and 4x is moderate, and above 4x starts to raise eyebrows. Above 6x and you are in territory where even the company’s accountants are sleeping badly. As Wall Street Prep notes in their leverage analysis resources, higher ratios suggest the company is near or beyond its comfortable debt capacity. See: Wall Street Prep — Leverage Ratio.

I always say: if a company’s Debt-to-EBITDA is so high that you need to read it twice to believe it, you should probably trust your instincts the second time.

Ratio 3: The Interest Coverage Ratio (ICR)

Formula: EBIT (Earnings Before Interest and Taxes) ÷ Interest Expense

This might be my personal favourite ratio. The Interest Coverage Ratio tells you how many times over a company could pay its interest bill with its operating earnings. An ICR of 3.0 means the company earns three times its annual interest expense — relatively comfortable. An ICR of 1.2 means it barely covers its interest costs, and one bad quarter could tip it into trouble.

As the CFA curriculum states clearly: the higher the interest coverage ratio, the more solvent the company is, indicating a stronger ability to service debt from operating earnings. A ratio below 1.5 should be considered a serious red flag. See: Analyst Prep — CFA Level 1: Leverage & Coverage Ratios.

Imagine your friend says they can cover their rent three times over with their monthly income. Great! Reliable. You would lend them money. Now imagine your other friend says they can cover rent 1.1 times over, and their income depends on their side hustle going well. That friend is the second company. Do not lend that friend money. Actually, call that friend and check if they are okay, but do not lend them money.

Ratio 4: The Debt-to-Assets Ratio

Formula: Total Debt ÷ Total Assets

This ratio tells you what proportion of the company’s assets are financed by debt. A ratio of 0.4 means 40% of assets are debt-financed; 0.7 means 70%. The higher this ratio, the more the company relies on borrowed money to fund what it owns.

For capital-intensive industries like manufacturing, energy, and telecom, higher ratios are normal and expected — these businesses need enormous physical assets to operate. For technology companies and service businesses, a high debt-to-assets ratio is less typical and often more worrying, because their assets are largely intangible and harder to liquidate if things go wrong.

As noted by Allianz Trade in their leverage ratio analysis: sectors and industries will typically have different average debt to equity ratios depending on the operational structures. Capital-intensive industries such as utilities or telecoms might have higher sector ratios because they need to fund expensive infrastructure. See: Allianz Trade — Leverage Ratios.

Ratio 5: The Net Debt-to-EBITDA Ratio

Formula: (Total Debt − Cash and Cash Equivalents) ÷ EBITDA

This is the grown-up version of Debt-to-EBITDA. It accounts for the cash the company has on hand to offset its debt. Why? Because if a company owes £100 million but has £80 million in cash sitting in the bank, its net debt position is really only £20 million.

Warren Buffett famously focuses on a company’s net debt position when assessing financial health. And while I am not Warren Buffett — I know because my portfolio has told me this loudly and repeatedly over the years — the principle is sound. Cash offsets debt. Always use net debt when you have the full picture.

Quick Summary — The Five Ratios Every Beginner Needs: D/E Ratio | Debt-to-EBITDA | Interest Coverage Ratio | Debt-to-Assets | Net Debt-to-EBITDA. Master these five and you are already ahead of most retail investors.

Section 3: How to Actually Do the Analysis — A Step-by-Step Method

Alright, we have the theory. Now let us talk about the method. Because knowing what these ratios are is one thing. Knowing what to do with them is where the real value is. I am going to walk you through a simple, repeatable process that you can apply to any publicly listed company.

Step 1: Find the Financial Statements

For any publicly listed company, the financial data you need is freely available. In the UK, companies file with Companies House. US-listed companies file 10-K annual reports with the SEC. You can find them on the company’s investor relations page, on sites like Macrotrends, Wisesheets, or directly through SEC EDGAR.

You are looking for three documents: the Balance Sheet (for total debt, assets, and equity), the Income Statement (for EBIT, interest expense, and EBITDA), and the Cash Flow Statement (for free cash flow, which gives context to everything else).

I know what you are thinking. ‘That sounds like a lot of documents.’ It is three documents. You look at three documents. Not three hundred. Three. If you are currently managing to watch three-episode story arcs on Netflix, you can handle three financial documents. I believe in you.

Step 2: Calculate the Five Ratios

Once you have your numbers, calculate all five ratios listed in Section 2. Do not skip any. Each one tells you something slightly different about the debt picture. Together they form a holistic view.

Here is a simple template to fill in:

• D/E Ratio: Total Debt ÷ Shareholders’ Equity = ?
• Debt-to-EBITDA: Total Debt ÷ EBITDA = ?
• Interest Coverage Ratio: EBIT ÷ Interest Expense = ?
• Debt-to-Assets: Total Debt ÷ Total Assets = ?
• Net Debt-to-EBITDA: (Total Debt − Cash) ÷ EBITDA = ?

Note down the numbers and move to step three. Resist the urge at this stage to panic or celebrate. The numbers mean very little in isolation — which brings us to the most important step of all.

Step 3: Compare Against Industry Benchmarks

This is where most beginners go wrong. They look at a company’s D/E ratio of 1.8 and think that is terrible. But if the industry average is 2.5, that company is actually relatively conservatively financed. Context transforms everything.

Always compare your ratios to: (a) the company’s own historical ratios over three to five years, and (b) the average ratios of its direct competitors and sector peers. FE Training’s leverage ratio resources make this point clearly: leverage ratios are often compared to an industry benchmark as an indicator of how levered the company is. See: FE Training — Leverage Ratios.

A company with a D/E of 0.5 in an industry where everyone else sits at 0.4 is actually quite average. A company with a D/E of 0.5 in an industry where the norm is 0.1 is carrying meaningful extra leverage. Same number, entirely different story.

Step 4: Look at the Trend

One year of data is a snapshot. Three to five years of data is a story. You want to know whether the debt ratios are improving, stable, or deteriorating. A company whose D/E ratio has crept from 0.8 to 1.2 to 1.9 over three years is telling you something important: its debt is growing faster than its equity. That trend should prompt further questions.

Conversely, a company whose interest coverage ratio has improved from 2.0 to 4.5 over five years is demonstrating that it is generating stronger earnings relative to its interest costs — a very positive sign. The trend is your friend. Or in this case, the trend is your financial due diligence.

Step 5: Read the Notes and Management Commentary

I cannot stress this enough: the notes to the financial statements are where the real story lives. They will tell you about the maturity profile of the debt (when it is due to be repaid), the interest rate structure (fixed vs floating), and any covenants (conditions lenders have placed on the debt).

Debt covenants are particularly important. These are conditions that, if breached, can trigger immediate repayment of the entire debt facility. Common covenants include maintaining a minimum interest coverage ratio or a maximum D/E ratio. As Wall Street Prep notes: breaching a loan covenant can result in penalties or trigger an immediate repayment, illustrating the importance of maintaining sustainable debt levels.

And yes, reading the notes is tedious. It is quite possibly the least glamorous activity in all of investing. But you know what else is tedious? Explaining to your spouse why the share you bought without reading the notes is now worth thirty percent less because the company breached a covenant you would have noticed if you had read page 47 of the annual report.

Section 4: Case Study 1 — Toys R Us and the Debt That Ate a Childhood

Let us apply the method to one of the most famous debt-related corporate collapses in recent history: the bankruptcy of Toys R Us in 2017–2018.

Background

In 2005, the legendary toy retailer was acquired in a leveraged buyout (LBO) by a consortium of private equity firms — KKR, Bain Capital, and Vornado Realty Trust — for approximately $6.6 billion. In an LBO, the acquirers use large amounts of debt to fund the purchase, with the acquired company’s own assets and future cash flows pledged as collateral.

At the time, this might have seemed manageable. Toys R Us was an established brand, a dominant market player, and apparently stable. The PE firms loaded it up with $5 billion in debt and fully expected the cash flows to service it.

Spoiler alert: that did not work out.

What the Ratios Would Have Told You

Had any investor applied the simple debt analysis method to Toys R Us in the years following the LBO, the warning signs were glaring:

• The Debt-to-EBITDA ratio ballooned to levels that left the company with almost no financial flexibility. Industry analysts noted the company was spending upwards of $400 million per year just on interest payments.
• The Interest Coverage Ratio deteriorated sharply, particularly after the 2008 financial crisis, when revenue softened and refinancing became more expensive.
• Cash flows were chronically insufficient to fund meaningful investment in e-commerce transformation or store improvements — because all the cash was going to service debt.

Harvard Business School’s analysis of Toys R Us using DuPont Decomposition found that the company had an equity multiplier (a measure of financial leverage) of 5.35 at the time of its collapse, alongside a negative net profit margin. See: Harvard Business School Online — Breaking Down the Demise of Toys R Us.

MIT Sloan Management faculty commented: ‘I think that the main lesson is that taking a lot of debt is risky… any company that issues a lot of debt with significant, complex debt structure has to understand it is risky, and there are costs and benefits of doing that.’ See: MIT Sloan — Here’s What Sunk Toys R Us.

The academic research published in the proceedings of the Atlantis Press is also instructive: the 2005 LBO resulted in a capital structure that was radically restructured, with debt replacing considerable equity, and that ‘a false assumption of a consistent market environment led to this case.’ See: Atlantis Press — The Study of Toys R Us LBO Failure.

The Lesson

Toys R Us did not go bankrupt because toys stopped being popular. It went bankrupt because it could not afford to compete with Amazon while paying $400 million a year in interest. Every pound that should have gone into digital transformation went to lenders instead. The debt was the anchor that stopped the ship from steering.

If you had run the simple five-ratio debt analysis on Toys R Us in 2010 and compared it to its peers, you would have seen a company carrying dramatically more debt than its operations could comfortably service, with a deteriorating interest coverage ratio and zero financial flexibility. That alone should have been enough to stay well away.

They went from children’s toy empire to cautionary tale in thirteen years. Let that marinate. And then let it marinate some more while you go look at the debt ratios of every company you are considering investing in.

Section 5: Case Study 2 — Lehman Brothers and the Leverage That Broke the World

If Toys R Us is the cautionary tale for retail investors, Lehman Brothers is the cautionary tale for the entire global financial system. When Lehman Brothers filed for Chapter 11 bankruptcy in September 2008, it was the largest bankruptcy in United States history, with approximately $600 billion in assets. And debt analysis tells you almost everything you need to know about why it happened.

The Leverage Problem

In the years leading up to its collapse, Lehman Brothers operated with a financial leverage ratio — total assets to equity — of approximately 30 to 1. That means for every dollar of equity, the firm was carrying thirty dollars of assets funded by debt. Let me put that in perspective: that is like buying a £300,000 house with £10,000 of your own money and £290,000 of borrowed money, then betting the entire thing on property prices only going up.

That is not investing. That is called something else entirely, and the words are not printable in a serious financial article.

The Yale Program on Financial Stability’s comprehensive case study on the Lehman Brothers Bankruptcy documents how the firm’s extraordinary leverage levels made it uniquely vulnerable to the slightest decline in asset values. The examiner found that Lehman had been manipulating its reported leverage ratio through accounting manoeuvres known as ‘Repo 105’ transactions. See: Yale Journal of Financial Crises — Lehman Brothers Bankruptcy Overview.

What a Simple Debt Analysis Would Have Shown

For any analyst running a basic debt analysis on Lehman Brothers between 2005 and 2008, the signals were there:

• Leverage ratios of 30:1 or higher were dramatically above what could be considered safe for any institution.
• The interest coverage ratio was dependent on continued smooth functioning of short-term debt markets, meaning any disruption would immediately create a liquidity crisis.
• Debt maturity analysis would have revealed that enormous proportions of Lehman’s liabilities were short-term — funded overnight in repo markets — making the firm extraordinarily vulnerable to a loss of market confidence.

As the Yale case study notes, before its failure, $200 billion of Lehman’s assets were funded with secured overnight loans, largely repos, 80% of which came from just 10 institutions. When those institutions got nervous and pulled back, it was game over.

The Lesson

The Lehman Brothers collapse illustrates two critical principles of debt analysis for investors:

• Absolute leverage levels matter enormously. A leverage ratio of 30:1 is not a business operating with debt — it is a business gambling with debt. Any investment in such an entity requires an almost flawless execution of assumptions.
• Debt maturity matters as much as debt quantity. Long-term debt gives a company time to weather storms. Short-term debt can evaporate overnight if confidence deteriorates. Always look at when the debt is due.

Now, I am not suggesting you could have single-handedly shorted Lehman Brothers into oblivion based on these ratios — although if you had, you would be very rich and very smug right now. But you would have known to stay well away from their bonds and equity. And that is exactly the point of debt analysis: not to predict the future, but to avoid the worst surprises.

Section 6: Common Beginner Mistakes in Debt Analysis

Now that we have covered the method and the case studies, let me save you from yourself by outlining the most common mistakes that beginners make when analysing company debt. I have made most of these myself. Some of them more than once. I am not proud of this, but I am committed to your financial education.

Mistake 1: Looking at D/E in Isolation

Seeing a D/E ratio without industry context is like seeing a temperature reading without knowing whether it is Celsius or Fahrenheit. 38 degrees in Celsius means a mild fever. 38 degrees in Fahrenheit means you are about to freeze. Context is not optional — it is mandatory.

Mistake 2: Ignoring Off-Balance-Sheet Debt

Some companies are creative about where they put their liabilities. Operating lease obligations, pension deficits, and certain financial instruments can carry debt-like characteristics without appearing as traditional debt on the balance sheet. The Lehman Brothers case is the most dramatic example of this, but the practice is not limited to investment banks.

Always read the notes. Always. I said this earlier and I will say it again because clearly it bears repeating.

Mistake 3: Assuming High Debt Means Bad Investment

This is the mirror-image mistake. Some of the greatest companies in the world carry significant debt and have done so profitably for decades. Amazon, Apple, and Microsoft have all carried meaningful debt on their balance sheets at various points. The question is not whether the debt exists — it is whether the company’s earnings can comfortably service it and whether the debt is being deployed productively.

As the NBER working paper on leverage dynamics (Working Paper No. 26802) makes clear, the opportunity cost of debt and its role in investment decisions is far more nuanced than simply labelling debt as good or bad. See: NBER Working Paper No. 26802 — Leverage Dynamics.

Mistake 4: Not Looking at the Trend

A D/E of 1.2 looks fine in isolation. A D/E that has gone from 0.3 to 0.7 to 1.2 over three years is a completely different story. That trajectory tells you the company is taking on debt faster than it is growing equity — which should prompt serious questions about capital allocation.

Mistake 5: Forgetting About Interest Rate Risk

In a low interest rate environment, companies can carry significant debt comfortably. When rates rise — as they did sharply in 2022 and 2023 — companies with floating-rate debt or debt up for refinancing suddenly face dramatically higher interest costs. Always check whether the debt is fixed or floating rate, and when it matures.

A company with an interest coverage ratio of 3.0 might look comfortable — until you realise half its debt is floating-rate and refinances next year, at which point the coverage ratio drops to 1.3. Then it is less comfortable. Then it is a three-in-the-morning worry. Ask me how I know.

Section 7: The Trader’s Quick-Check System — Your 10-Minute Debt Audit

You have come this far. Let me reward you with the distilled, practical version — a ten-minute system you can run on any company before you invest. I use a version of this every single time I look at a new position.

The 10-Minute Company Debt Audit

Minutes 1–2: Pull the balance sheet and income statement. Find total debt (current + long-term), total equity, total assets, EBITDA, EBIT, and interest expense.

Minutes 3–4: Calculate the five ratios. D/E, Debt-to-EBITDA, Interest Coverage, Debt-to-Assets, Net Debt-to-EBITDA. Write them down. Seeing them all together tells a story.

Minutes 5–6: Find the industry average for each ratio. Sites like CSIMarket, Macrotrends, and Damodaran Online (Aswath Damodaran at NYU publishes industry data annually and it is completely free) provide sector benchmarks. Compare your numbers.

Minutes 7–8: Look at three years of trend data. Are the ratios improving or deteriorating? Is the interest coverage rising or falling? Is net debt growing or shrinking as a proportion of EBITDA?

Minutes 9–10: Check debt maturity and structure in the notes. When is the debt due? Fixed or floating rate? Any covenants that could be triggered?

Ten minutes. That is all it takes to form a meaningful, evidence-based view of a company’s debt position. And yet the number of investors who skip this entirely and just buy based on a hot tip from someone in a trading forum is… significant. Alarmingly significant.

Trader’s Rule: Never buy a company whose debt structure you cannot explain in three sentences. If you cannot summarise it simply, you do not understand it well enough to own it.

Section 8: Debt Analysis for Different Types of Companies

One more important concept before we wrap up: debt analysis looks different depending on the type of company you are examining. Let me give you a quick guide.

Cyclical Companies (Mining, Energy, Retail, Automotive)

These businesses have earnings that fluctuate significantly with economic cycles. For cyclical companies, you want low to moderate leverage — because when the cycle turns down and earnings fall sharply, a highly leveraged cyclical company can find itself unable to service its debt very quickly. The ideal interest coverage ratio for a cyclical company should be tested not just at current earnings, but at a through-cycle low.

Utility and Infrastructure Companies

Regulated utilities and infrastructure businesses have highly predictable, contracted cash flows. These companies can safely carry much higher debt loads than cyclical businesses. A D/E of 2.0 to 3.0 is not unusual or alarming in this sector. The stable revenues mean the interest coverage ratio remains robust even in downturns.

Technology and Growth Companies

Many high-growth technology companies carry little or no debt in their early stages, choosing to fund growth through equity. When they do take on debt, it is worth watching carefully — because their asset base is largely intangible and would not provide meaningful collateral in a distressed scenario. Remember Netflix, which as of 2019 carried a Debt-to-Equity Ratio of nearly 195, funding its content war almost entirely on borrowed money. It worked out. Not every streaming service was so fortunate.

Financial Companies (Banks, Insurers, Asset Managers)

This is where debt analysis becomes genuinely complex. Financial companies have fundamentally different balance sheet structures, and the traditional leverage ratios used for industrial companies are not directly applicable. Banks are regulated separately, with capital ratios (Tier 1, Tier 2) being the primary metrics. This is a separate topic, and frankly a separate article, possibly a separate career. Approach with caution and respect.

Conclusion: You Now Know More Than Most People Investing Today

Let us take stock of where we are. You started this article not knowing your Debt-to-EBITDA from your Interest Coverage Ratio. You have now learned:

• Why debt matters to investors, and why it is neither automatically good nor automatically bad
• The five key ratios: D/E, Debt-to-EBITDA, Interest Coverage, Debt-to-Assets, and Net Debt-to-EBITDA
• A simple five-step process for analysing any company’s debt position
• Two major real-world case studies showing what happens when debt is ignored or mismanaged
• The most common mistakes beginners make — and how to avoid them
• A ten-minute audit system you can apply immediately
• How debt analysis differs across sectors and company types

That is a lot. Be proud of yourself. And then immediately go test it on a company you have been considering investing in, because knowledge without application is just expensive trivia.

The truth is, company debt analysis is one of the most powerful tools in any investor’s toolkit, and it is dramatically underused by retail investors who get distracted by revenue growth rates and exciting product launches. A company can have a revolutionary product and still go bankrupt if it is drowning in debt it cannot service. Conversely, a boring, unglamorous company with clean finances and strong cash flow coverage can be one of the safest, most profitable investments you ever make.

I started this article talking about my nightmares involving interest coverage ratios. Here is the update: the nightmares have not stopped. But they are now nightmares about companies I did not invest in because I ran the debt analysis and walked away. That is a much better kind of nightmare. That is the nightmare of someone who did their homework.

Go do your homework. Your future self — and your future portfolio — will thank you.

And if you ever find yourself at a dinner party and someone mentions a company with a D/E of 4.0 and a deteriorating interest coverage ratio as a ‘can’t miss’ opportunity, I want you to remember this article. And then I want you to slowly put your phone away, nod politely, and change the subject.

You know better now. Use it.

References

1. Arhinful, R. & Radmehr, M. (2023). The Impact of Financial Leverage on the Financial Performance of the Firms Listed on the Tokyo Stock Exchange. SAGE Open. https://journals.sagepub.com/doi/10.1177/21582440231204099

2. Demirci, I., Huang, J. & Sialm, C. (2017). Government Debt and Corporate Leverage: International Evidence. NBER Working Paper No. 23310. https://www.nber.org/system/files/working_papers/w23310/w23310.pdf

3. Bolton, P., Wang, N. & Yang, J. (2020). Leverage Dynamics and Financial Flexibility. NBER Working Paper No. 26802. https://www.nber.org/system/files/working_papers/w26802/revisions/w26802.rev1.pdf

4. Wiggins, R.Z. & Metrick, A. (2014). The Lehman Brothers Bankruptcy A: Overview. Yale Program on Financial Stability, Journal of Financial Crises, Vol. 1, Iss. 1. https://elischolar.library.yale.edu/cgi/viewcontent.cgi?article=1000&context=journal-of-financial-crises

5. Casey, A.J. & Tuckman, B. (2018). Toys R Us and Bankruptcy: Death by Disruption, Not Debt. Columbia Law School Blue Sky Blog. https://clsbluesky.law.columbia.edu/2018/04/23/toys-r-us-and-bankruptcy-death-by-disruption-not-debt/

6. Chen, J. et al. (2022). The Study of Toys R Us LBO Failure. Atlantis Press. https://www.atlantis-press.com/article/125973768.pdf

7. Harvard Business School Online (2018). Breaking Down the Demise of Toys R Us. HBS Online Blog. https://online.hbs.edu/blog/post/breaking-down-the-demise-of-toys-r-us

8. MIT Sloan Management Review (2018). Here’s What Sunk Toys R Us. MIT Sloan Ideas Made to Matter. https://mitsloan.mit.edu/ideas-made-to-matter/heres-what-sunk-toys-r-us

9. Corporate Finance Institute. Leverage Ratios. CFI Education. https://corporatefinanceinstitute.com/resources/accounting/leverage-ratios/

10. Analyst Prep (2019). Calculate Leverage Ratio & Coverage Ratio — CFA Level 1. AnalystPrep. https://analystprep.com/cfa-level-1-exam/financial-reporting-and-analysis/calculate-leverage-ratio-coverage-ratio/

11. Wall Street Prep. Leverage Ratio Formula and Calculations. Wall Street Prep Knowledge Base. https://www.wallstreetprep.com/knowledge/leverage-ratio/

12. FE Training. Leverage Ratios: Definition, Metrics, Excel Example. FE Training Free Resources. https://www.fe.training/free-resources/accounting/leverage-ratios/

13. Allianz Trade. Leverage Ratios: Different Types Explained, Impact and Examples. Allianz Trade Insights. https://www.allianz-trade.com/en_US/insights/leverage-ratios.html

Disclaimer

This article is for educational and informational purposes only and does not constitute financial advice. The author is not a licensed financial adviser. Always conduct your own due diligence and consult a qualified financial professional before making investment decisions.

Further Reading: 

1. Balance sheet vs profit and loss
2. Common balance sheet mistakes
3. Negative balance sheet explained
4. Fundamental Analysis of US Stocks
5. UK SME financial insights
6. Machine Learning