Guide 8 minutes
Is this company borrowing too much? A five-check debt test
One number never tells you whether a company owes too much. Five checks, each from a different page of the annual report, usually do. We run them on Sameer Chai and say what would change the answer.
The kulhad chai chain down the road might be for sale. Sameer has done the sum on a napkin: ₹12 crore. His first idea is to borrow it.
SameerBanks love us. Can we just take another loan?
RiyaMaybe. But before anyone lends us a rupee, they'll test what we already owe. Let's run the test on ourselves first. Five checks. Each one looks at debt from a different side, and each one has a line where it starts to worry people.
Here's the result card before the detail.
| Check | Where you find it | Sameer Chai, FY26 | Verdict |
|---|---|---|---|
| 1. Debt-to-equity | Balance sheet, ratios note | about 0.18 | Light |
| 2. Interest cover | P&L | 7× | Comfortable |
| 3. Current ratio | Balance sheet, ratios note | about 4.3 (0.67 without cash) | Fine, for a chai business |
| 4. Credit rating | Corporate governance report | A– (Stable) | Adequate safety |
| 5. Contingent liabilities | Notes to the accounts | ₹1.2 crore | Small next to equity |
The first test, how much is borrowed
Debt-to-equity
Borrowings divided by net worth. Sameer Chai has one ₹20 crore bank loan and ₹110 crore of net worth: 20 ÷ 110, about 0.18. Eighteen paise of loans for every rupee of owners' money.
Go one step further and subtract cash. We hold ₹55 crore, more than the loan, so net debt is 20 − 55 = minus ₹35 crore. In plain words, we could repay the loan tomorrow and still have ₹35 crore left.
| Sameer Chai | What would worry you |
|---|---|
| 0.18, and more cash than debt | A ratio that climbs year after year; one well above its own industry; "debt" that leaves out lease liabilities when rivals include them |
The ratio alone can mislead, because what counts as debt varies. The ratios note in the annual report says what went into the sum. Read it before you compare two companies.
The second test, can the profit pay the interest
Interest cover
This is the check lenders care about most, and the one beginners skip. Divide operating profit (EBIT) by the interest bill.
- EBIT: ₹18 crore of EBITDA − ₹4 crore of depreciation and amortisation = ₹14 crore.
- Interest: ₹2 crore (10% on the ₹20 crore loan).
- Interest cover: 14 ÷ 2 = 7×.
The chai business earns its interest seven times over. EBIT could fall from ₹14 crore to ₹2 crore, a drop of about 86%, before it only just covered the interest: at ₹2 crore, cover is exactly 1.
SameerWhy EBIT and not net profit?
RiyaBecause interest is paid before tax, out of operating profit. Net profit is what's left after the interest has already gone.
| Sameer Chai | What would worry you |
|---|---|
| 7× | Cover sliding towards 1, where every rupee of operating profit goes to the lender; cover kept up only by other income, like interest on deposits |
Listed companies must explain in their management discussion any change of 25% or more in interest coverage. If it has fallen sharply, that paragraph is where the company has to say why.
Now try the napkin plan. If Sameer borrowed the whole ₹12 crore at the same 10%, interest would rise by ₹1.2 crore to ₹3.2 crore. On today's ₹14 crore of EBIT, cover would be about 4.4×, before counting anything the new stalls earn. Lower, but a long way from 1.
The third test, can it pay this year's bills
Current ratio
What turns into cash within a year, divided by what falls due within a year. Ours: ₹65 crore (stock 5, customer dues 5, cash 55) ÷ ₹15 crore (suppliers 10, other bills 5) = about 4.3.
That looks very safe, but most of it is idle IPO cash. Take the cash out and it's 10 ÷ 15, about 0.67. For a business whose customers pay on the spot and whose suppliers wait a few weeks, that's normal.
| Sameer Chai | What would worry you |
|---|---|
| 4.3, or 0.67 without cash | A ratio below 1 at a business whose own customers pay slowly; a big slice of long-term loans falling due within the year; cash that's mostly borrowed short-term |
This check is about the next twelve months. Debt-to-equity is about the whole structure. A company can pass one and fail the other.
The fourth test, what an outsider thinks
The credit rating
The first three checks are sums you do yourself. A credit rating is a SEBI-registered agency doing a deeper version and publishing its opinion. Our ₹20 crore loan is rated A– (Stable): an adequate degree of safety, at the lower end of the A group, with no change expected soon.
Listed companies list every rating, and any revision during the year, in the corporate governance report. They must also tell the stock exchanges when they get a new rating or a revised one, so a change shows up in exchange filings long before the next annual report.
| Sameer Chai | What would worry you |
|---|---|
| A– (Stable) | A downgrade; an outlook turning Negative; a note that the company has stopped co-operating with the agency; ratings that differ sharply between two agencies |
A rating is about repaying debt, not about the share price. A company can be AAA and a poor investment, or BBB and a good one.
The fifth test, debts that aren't on the balance sheet yet
Contingent liabilities
The first four checks only see what's already booked. Contingent liabilities are possible bills the company says it probably won't pay, so they sit in the notes, not on the balance sheet. Ours is a ₹1.2 crore GST notice the company disputes and has appealed.
Size it three ways:
- Against net worth: 1.2 ÷ 110, about 1.1%.
- Against a year's profit: 1.2 ÷ 9, about 13%.
- Against cash: 1.2 ÷ 55, about 2.2%.
If we lost, it would hurt a year's profit, but not the balance sheet.
| Sameer Chai | What would worry you |
|---|---|
| ₹1.2 crore, about 1% of net worth | A total that's a big share of net worth; one that grows every year; guarantees given for loans taken by group or promoter companies, which become the company's debt if the other side can't pay |
Guarantees are the one to hunt for. They're the closest thing to hidden borrowing, and they often sit in the same note. The auditor's CARO annexure also lists taxes not paid because of a dispute, which is a useful cross-check.
Reading the five together
No single check gives the verdict. They work as a set.
- High debt-to-equity with high interest cover can be fine: the business earns enough to carry it.
- Low debt-to-equity with low interest cover is odd, and worth a question: either profit is weak, or the interest rate is very high.
- A falling current ratio and a downgrade in the same year is the pairing lenders react to fastest.
- A clean balance sheet with large guarantees in the notes isn't clean.
SameerSo can we borrow the ₹12 crore?
RiyaOn these five, we'd pass. Whether we should is a different question. We also have ₹55 crore in the bank.
SameerAh.
RiyaLenders will ask that one too.