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L.2 · INTERMEDIATE · 3 MIN

Key Credit Metrics: Leverage, Coverage, and Liquidity

Three metric families drive credit ratings: leverage (how much debt), coverage (can they pay interest), and liquidity (can they survive a cash crunch). Together, these tell you whether a company’s debt is safe, adequate, or dangerous.

Quiz · 5 questions ↓
§ 01
AAPL — Debt/Equity. Open AAPL on the Ledge to see current values.
§ 02
MetricFormulaStrongAdequateDanger
LeverageTotal Debt / EBITDA< 3x3–5x> 5x
Interest CoverageEBITDA / Interest Expense> 4x2–3x< 2x
LiquidityCash + Revolver / Near-term Maturities> 1.5x1.0–1.5x< 1.0x
§ 03
Leverage = Total Debt / EBITDA
§ 04

Watch the trend, not just the level. A company at 3x leverage and improving is healthier than one at 3x and deteriorating. Credit is about trajectory — where the metrics are heading matters as much as where they are today.

§ 05
Pull up a company in **Fundamentals**. Calculate Debt/EBITDA and Interest Coverage. Where does it fall on the risk spectrum?
§ 06
Company A: 4x leverage, 3x coverage, declining. Company B: 5x leverage, 4x coverage, improving. Which is riskier?
§ 07

Credit metrics are early warning systems. When leverage rises and coverage falls for 2+ consecutive quarters, the market is usually 6–12 months behind in repricing the risk.

§ 08
A company has Net Debt/EBITDA of 3.0x, Interest Coverage of 6.0x, and Current Ratio of 1.8. Is this investment-grade credit?
§ 09

Going Deeper — five hidden debt items investors miss. Reported debt / EBITDA understates true leverage when the balance sheet excludes: (1) capitalized operating leases (material for retailers and airlines), (2) pension and OPEB underfunding (PBO − plan assets), (3) finance-subsidiary debt at auto OEMs and equipment makers, (4) trade payables stretched well beyond industry-norm DPO, (5) factored / securitized receivables held off balance sheet. Worked example: a 3.5x reported leverage ratio with $800M of pension underfunding on $400M of EBITDA is actually 5.5x adjusted leverage — a meaningfully different credit profile.

Five questions · AI feedback

Sit with the ideas.

Company A: 6x leverage, 1.5x interest coverage, $200M cash, $500M debt due in 12 months. Company B: 4x leverage, 3x interest coverage, $1B cash, no debt due for 3 years. Which is higher credit risk?

Why:

Other lessons in this course.

  1. 01The Five Cs of Credit Analysis
  2. 02Key Credit Metrics: Leverage, Coverage, and Liquidity— reading now
  3. 03Credit Deterioration: The Warning Signs
  4. 04Recovery Analysis: What Do You Get If They Default?
  5. 05Altman Z-Score: Quantifying Bankruptcy Risk
  6. 06Covenant Taxonomy: Reading an Indenture by Purpose
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