Debt, Leverage and Coverage
Borrowing magnifies returns in both directions. The ratios that matter are how much is owed relative to earnings, and how comfortably the interest is covered.
MadStockAlerts Research · Updated August 28, 2026
What to take away
- Net debt nets cash against borrowings and is the more useful figure.
- Net debt to EBITDA is the standard measure of how heavy a debt load is.
- Interest coverage measures the cushion between profit and the interest bill.
- Maturity schedule matters as much as quantity: refinancing risk is a timing problem.
- Tolerable financial leverage depends entirely on how stable earnings are.
MAD Academy Training Video · 0:45
Debt Is Fine Until It Is Due
Leverage ratios say how much a company owes; coverage ratios say whether it can pay. The second question is the urgent one.
This lesson is part of a Stock Alerts + Tools plan.
The measures
net debt = total borrowings - cash and equivalents
leverage = net debt / EBITDA
- roughly how many years of current earnings the borrowings represent
interest coverage = operating income / interest expense
- how many times over the interest bill is covered by operating profit
What the levels mean
| Net debt / EBITDA | Usual reading |
|---|---|
| Below 1x | Conservatively financed, considerable flexibility |
| 1x - 3x | Ordinary for an established business with stable earnings |
| 3x - 5x | Heavy; sensitive to a downturn in earnings |
| Above 5x | Highly leveraged; refinancing conditions become decisive |
Tolerable leverage depends entirely on how stable earnings are. A regulated utility carries 5x comfortably because its revenue is predictable. A cyclical manufacturer at 3x can be in more trouble, because its EBITDA can halve.
The right way to test it is to halve EBITDA and recompute. A company at 3x becomes 6x in a downturn without borrowing another dollar, and whether that breaches a covenant is a question with a documented answer.
The maturity wall
Debt is not owed evenly. The filing discloses the schedule year by year, and a large concentration falling due in one year is a specific, dated risk: the company must refinance at whatever rates prevail then, or repay it.
A company with modest total leverage and a large maturity concentrated in a year of tight credit conditions is in a worse position than the headline ratio suggests. Conversely, a heavily indebted company whose maturities are spread across a decade at fixed rates has bought itself a great deal of time.
The rate matters as much as the date. Debt issued at two percent that matures into a six percent market triples the interest cost on refinancing, which is a foreseeable event with a known date.
Scroll the chart sideways to see all of it.
Covenants
Loan agreements typically require ratios to stay within limits. Breaching a covenant can make debt immediately repayable, which turns a slow deterioration into a sudden crisis.
The covenants and the current headroom against them are disclosed in the filing notes, and searching a filing for the word covenant finds them in seconds. A company disclosing that it was in compliance with a specific ratio at a specific level has told you exactly how much room it has left.
Fixed, floating, and where the risk sits
Two companies with identical leverage ratios can face entirely different risks depending on how their debt is structured, and the structure is disclosed in the debt note rather than in any ratio.
- Fixed-rate debt locks the cost until maturity, moving the risk from the rate to the refinancing date.
- Floating-rate debt reprices continuously, so a rate rise reaches the income statement within a quarter.
- Secured debt is backed by specific assets, which subordinates everything else to it in a restructuring.
- Revolving credit is available capacity rather than drawn debt, and its covenants can restrict access precisely when it is needed.
The interaction between structure and the maturity schedule is what determines whether a debt load is manageable. A company with fixed-rate debt maturing in eight years has locked its cost and its risk is remote; the same leverage in floating-rate debt is a direct exposure to the policy rate, and the same leverage maturing next year is a refinancing question that will be answered at whatever rates prevail then.
Interest coverage, operating income divided by interest expense, is usually the more informative measure of the two, because it asks whether the debt can be serviced out of what the business earns rather than how large it is relative to a balance-sheet figure.
Covenants, and what breaching one does
Debt agreements contain conditions the borrower must satisfy, and they are disclosed in the debt note. They matter because a breach can accelerate the debt, making it immediately due, which converts a manageable balance into a solvency event without anything in the business changing.
| Type | What it requires | Where it bites |
|---|---|---|
| Maintenance covenant | A ratio to be met every period | Tested quarterly, so a bad quarter is enough |
| Incurrence covenant | A ratio to be met only when taking an action | Blocks new debt, dividends or acquisitions rather than triggering default |
| Negative covenant | A prohibition, such as on granting security | Restricts flexibility rather than testing performance |
| Cross-default | Default on one instrument triggers others | Turns a single breach into a general one |
The distinction in the first two rows is the one that decides how much room a company has. Maintenance covenants are tested whether or not the company does anything, so a decline in earnings alone can breach them. Incurrence covenants only bind when the company wants to act, which is why leveraged borrowers negotiate hard for them.
Headroom against a covenant is sometimes disclosed and often calculable from the ratio definition in the agreement, which is filed as an exhibit. A company operating close to a maintenance covenant has far less capacity to absorb a weak quarter than its leverage ratio alone suggests.