Debt-to-Equity, Debt-to-Capital & Interest Coverage

Builds onDuPont Decomposition (3-Way) — if this page feels steep, start there.

D/E = \frac{\text{Total debt}}{\text{Total equity}} \qquad D/C = \frac{\text{Total debt}}{\text{Total debt} + \text{Total equity}} \qquad \text{Interest coverage} = \frac{EBIT}{\text{Interest expense}}

$\text{Total debt}$: interest-bearing debt: short- and long-term borrowings
$\text{Total equity}$: total shareholders' equity
$D/E$: debt sized against equity alone — how many dollars of debt per dollar the owners put in
$D/C$: debt's SHARE of the whole capital structure (debt + equity combined)
$EBIT$: earnings before interest and taxes — operating income, before financing costs
$\text{Interest coverage}$: how many times operating income could pay this year's interest expense

Why it must be true

DuPont's equity multiplier already hints that leverage matters, but it doesn't say HOW MUCH debt sits in the capital structure or whether the company can actually service it. These three ratios answer that directly, from two angles: how the pie is financed (debt-to-equity and debt-to-capital both size the debt load, just against a different base), and whether the company can pay for it (interest coverage — the number of times operating income could pay the interest bill before there'd be nothing left).

A company can carry a large debt load safely if its operating income comfortably covers the interest — or carry a modest load dangerously if a thin operating margin barely covers it. Sizing the debt and testing whether it can be serviced are two different, complementary questions.

The derivation

Debt-to-equity compares the two financing sources directly against each other:

D/E = \frac{\text{Total debt}}{\text{Total equity}}

Debt-to-capital instead asks what SHARE of the whole capital structure is debt — dividing by the sum of both sources rather than equity alone:

D/C = \frac{\text{Total debt}}{\text{Total debt} + \text{Total equity}}

Interest coverage steps away from the balance sheet entirely and asks a cash-servicing question: how many times over could operating income (EBIT) pay this year's interest bill?

\text{Interest coverage} = \frac{EBIT}{\text{Interest expense}}

When to reach for it

Assessing how much debt a company carries and whether its operating earnings can comfortably service that debt — for credit analysis, bond covenants, or leverage risk in an equity valuation.

Listen for

“debt-to-equity / debt-to-capital ratio”“interest coverage / times interest earned”“financial leverage and debt-servicing capacity”“covenant compliance / borrowing capacity”

Back-of-the-envelope

Estimate it in your head first — then the calculator only confirms.

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D/C is always LESS than D/E for any positive equity, since D/C's denominator (debt + equity) is bigger than D/E's denominator (equity alone) — a computed D/C above the D/E for the same company signals an error.
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Interest coverage below about 2–3× is a red flag in most industries; well above 8–10× suggests ample cushion. Judge against the company's own industry and history.
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D/C is a fraction between 0 and 1 by construction — a computed D/C above 1 or below 0 means a sign or ratio-direction error.

Traps in applying it

✗Confusing D/E and D/C — D/E divides by equity alone; D/C divides by the sum of debt and equity.
✗Using net income instead of EBIT in interest coverage — the ratio specifically measures OPERATING earnings' capacity to pay interest, before tax effects.
✗Treating rising leverage as bad in isolation without checking coverage — a highly levered but well-covered company can be safer than a lightly levered one with razor-thin interest coverage.

Limits & criticisms

Book-value debt and equity can diverge sharply from market values — a company's true leverage, marked to market, may look very different from its balance-sheet ratios, especially if book equity has been shrunk by buybacks or write-offs. Interest coverage also only tests THIS year's obligation; it says nothing about upcoming debt maturities that must be refinanced, which is often the more dangerous risk in a downturn.

Where it came from

Debt-to-equity and debt-to-capital have been core credit-analysis tools since bond covenants first began specifying maximum leverage ratios in the early 20th century, and they remain standard triggers in loan agreements today — breach one and a lender can often demand immediate repayment. Interest coverage (sometimes called the "times interest earned" ratio) became a headline metric after waves of over-leveraged buyouts in the 1980s made it clear that a company's SIZE of debt mattered less than its ability to actually service it quarter to quarter.

One identity, 3 questions

The exam can hide any variable. Each face below is the same equation solved for a different unknown — drill them separately.

Debt sized against equity

D/E = \frac{\text{Total debt}}{\text{Total equity}}

The classic leverage face: dollars of debt per dollar the owners contributed.

Drill this face →

Debt's share of the capital structure

D/C = \frac{\text{Total debt}}{\text{Total debt} + \text{Total equity}}

The capital-structure face: what fraction of ALL financing is debt.

Drill this face →

Times interest earned

\text{Interest coverage} = \frac{EBIT}{\text{Interest expense}}

The servicing face: whether operating earnings can actually afford the debt load.

Drill this face →

On the BA II Plus

Worked example: Total debt is $600.00m and total equity is $300.00m. What fraction of the capital structure is debt?

1.600 [÷] (600 [+] 300) [=]debt over debt plus equity

→ 0.6667

Drill this formula Back to the library