Valuation ratios tell you the price. Return ratios tell you the quality. This third group tells you whether the company survives a bad year — and it is the group that turns first when a business starts deteriorating, months before margins move.
Leverage: can it service the debt?
- Above 6×
- Comfortable. Interest is a minor item.
- 3× to 6×
- Manageable, but a bad year would compress it quickly.
- Below 2×
- Fragile. Most of the operating profit is going to lenders.
- Below 1×
- The business does not earn enough to pay its interest. It is surviving on refinancing.
Example: Debt-to-equity tells you how much is borrowed; interest coverage tells you whether that amount is affordable. A company can carry high debt safely if cash flows are utterly predictable — which is why utilities and toll roads sustain leverage that would destroy a cyclical manufacturer.
- Under 1×
- Very conservative
- 1× to 3×
- Normal for most Indian manufacturers
- Above 4×
- Lenders start imposing covenants; refinancing risk becomes real
Example: Read as "years of operating earnings required to repay all borrowings". It is the ratio credit rating agencies lead with, which makes it the one that determines the cost of the company’s debt.
Liquidity: can it pay this quarter’s bills?
| Ratio | Formula | What it adds |
|---|---|---|
| Current ratio | Current assets ÷ current liabilities | Broad short-term solvency. Below 1 means more is due within a year than is available. |
| Quick ratio | (Current assets − inventory) ÷ current liabilities | The stricter test. Excludes inventory, because unsold stock in a downturn is exactly what you cannot convert to cash. |
| Cash ratio | Cash ÷ current liabilities | The harshest test. Rarely above 0.5 for an operating company, and does not need to be. |
Efficiency: how hard are the assets working?
| Ratio | What it measures | Reading it |
|---|---|---|
| Asset turnover | Revenue ÷ total assets | Sales generated per rupee of assets. Retail runs high; heavy manufacturing runs low. Compare only within an industry. |
| Inventory days | (Inventory ÷ COGS) × 365 | How long stock sits before being sold. Rising means demand is slowing or the product is going stale. |
| Receivable days | (Receivables ÷ revenue) × 365 | How long customers take to pay. The single most useful early-warning number on the balance sheet. |
| Payable days | (Payables ÷ COGS) × 365 | How long the company takes to pay suppliers. Higher can mean bargaining power — or cash trouble. |
- Shortening
- The business is getting better at turning effort into cash
- Lengthening
- Cash is being trapped in the working-capital cycle
- Negative
- Customers pay before suppliers are paid — growth funds itself
Example: Well-run Indian retail and quick-service restaurant businesses often run a negative cycle. It is one of the strongest structural advantages a business model can have, because expansion requires no external funding.
A company shows a current ratio of 2.4, but receivable days rose from 62 to 148 and the quick ratio is 0.7. What is the situation?
Aapki salary ₹50,000 hai aur EMI ₹40,000 — thodi si naukri hili aur sab bigad gaya. Wahi EMI ₹12,000 hoti toh aaram se chalta. Company ka debt-to-equity aur interest coverage bilkul yahi hai: kamai ke muqable bojh kitna hai. Achhi company bhi zyada udhaar mein doob sakti hai.
- Debt-to-equity says how much is borrowed; interest coverage says whether it is affordable.
- Net debt to EBITDA is what rating agencies lead with, so it sets the cost of debt.
- The quick ratio strips out inventory — the asset you cannot sell in a downturn.
- Receivable days is the earliest reliable warning on the balance sheet.
- Compare every ratio to the company’s own five-year history and to direct peers.
Mark it done to track your progress through the curriculum.
Common questions
Short, direct answers to what people ask about this topic.
- interest coverage ratio meaning
- Interest coverage is EBIT divided by interest expense — how many times a company’s operating profit covers its interest bill. It answers whether the debt is affordable, where debt-to-equity only tells you how much there is. A company with predictable cash flows can safely carry debt that would sink a cyclical business.
- what is a good interest coverage ratio
- Above 6 times is generally comfortable, meaning interest is a minor claim on profit. Between 3 and 6 times is manageable but would tighten quickly in a bad year, and below 2 times is fragile. Below 1 means the business does not earn enough to pay its interest and is surviving on refinancing.
- quick ratio meaning
- The quick ratio is current assets excluding inventory, divided by current liabilities — a stricter test of whether a company can pay its short-term bills without having to sell stock. It matters most for businesses whose inventory is slow-moving or hard to sell in a hurry, where the ordinary current ratio can flatter the true position.
- what do receivable days tell you
- Receivable days measure the average number of days a company takes to collect payment from its customers after a sale. Rising receivable days mean cash is being tied up for longer, often because customers are being given generous credit to prop up sales or are struggling to pay — an early warning that appears well before it reaches the profit line.