Chapter 9 · Day 9 — Dividend, debt and liquidity
Debt, interest cover and liquidity
Leverage raises returns in good years and decides survival in bad ones. Interest cover is the ratio that matters most.
10 of 30 · 12 min
Debt is not bad. Debt that cannot be serviced in a weak year is.
| Ratio | Formula | Reads |
|---|---|---|
| Debt-to-equity | Total debt ÷ Shareholders' equity | How geared it is |
| Debt-to-assets | Total debt ÷ Total assets | Share of assets funded by debt |
| Interest coverage | EBIT ÷ Interest expense | How many times profit covers interest |
| Net debt | Total debt − Cash | Debt after available cash |
| Net debt / EBITDA | Net debt ÷ EBITDA | Years of earnings to repay |
Worked
Debt Rs 42,000k, equity Rs 87,600k → D/E = 0.48. EBIT Rs 18,000k, interest Rs 4,200k → interest cover = 4.3×. Net debt = 42,000 − 9,000 = Rs 33,000k → net debt/EBITDA = 1.45×.
Liquidity
- Current ratio = Current assets ÷ Current liabilities
- Quick ratio = (Cash + Marketable securities + Receivables) ÷ Current liabilities — inventory removed, because it may not sell
- Cash ratio = (Cash + equivalents) ÷ Current liabilities — the strictest test
Current assets Rs 48,000k, current liabilities Rs 31,000k → current ratio 1.55. Strip Rs 19,000k of inventory → quick ratio 0.94. The gap between those two numbers is the inventory question.
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