Solvency Ratios

Solvency ratios answer: can this company survive the long run? Is the debt manageable relative to earnings power and asset base? While liquidity ratios focus on the next 12 months, solvency ratios take a multi-year view of financial health.

The central question in solvency analysis is whether a company can comfortably service its debt through the economic cycle, including during a downturn when revenues fall and credit conditions tighten. A company with a Net Debt/EBITDA of 1.0× has very comfortable headroom; one at 6.0× is in territory where a 30% earnings drop could leave it unable to service debt.

For equity investors, solvency matters because financial distress is enormously costly. Companies that approach insolvency often raise dilutive equity, sell assets at distressed prices, or lose talent and contracts, destroying value even if they ultimately survive.

Key solvency ratios:

Net Debt / EBITDA Net Debt = Gross Borrowings − Cash & Liquid Investments How many years of operating earnings to repay net debt. Generally: < 2× comfortable, 2–4× moderate, > 4× elevated risk. For capital-intensive sectors (infra, power), 5–6× can be normal.

Debt / Equity (D/E) D/E = Total Borrowings ÷ Total Equity (Book) Simple leverage measure. Varies widely by sector. For Indian industrials, < 1× is conservative; 2–3× is moderate leverage.

Interest Coverage (ICR) ICR = EBIT ÷ Finance Costs A ratio of 3× or above is generally comfortable. Below 1.5× is a stress signal. Investment-grade companies in India typically maintain ICR above 3×.

Debt Service Coverage Ratio (DSCR) DSCR = (EBITDA or CFO) ÷ (Interest + Principal Repayment) Used in project finance and bank loan assessments. Below 1.0× means the company cannot service debt from operations, unsustainable.

Altman Z-Score (covered in Credit Analysis section) combines solvency and profitability into a distress probability score.