Debt-to-equity ratio: how to assess leverage in Indian companies

What the debt-to-equity ratio measures

The debt-to-equity (D/E) ratiomeasures the proportion of a company's funding that comes from debt versus equity. It is one of the most fundamental measures of financial leverage and capital structure risk.

D/E ratio = Total Debt ÷ Shareholders' Equity

Total debt here means all interest-bearing financial obligations — long-term loans from banks and financial institutions, non-convertible debentures (NCDs), commercial paper, short-term borrowings, and any other debt instruments on the balance sheet. Working capital credit lines (such as cash credit facilities) are typically included. Operational liabilities — trade payables, advance from customers — are not financial debt and are not included in the D/E numerator.

Shareholders' equity is the net worth figure: paid-up share capital plus reserves and surplus (retained earnings and other equity reserves) from the balance sheet.

A D/E of 1.0 means debt equals equity. A D/E of 0.5 means the company has borrowed half of its equity. A D/E of 3.0 means the company has borrowed three times its equity base. Zero D/E means the company has no interest-bearing debt.

Industry-level norms in India: why context is everything

The D/E ratio only makes sense in the context of the industry a company operates in. What is dangerously leveraged for one sector can be entirely normal and prudent for another. Here is how major Indian sectors historically positioned on leverage:

IT services: near-zero debt

Indian IT services majors — TCS, Infosys, Wipro, HCL Technologies, and others — historically operated with debt-to-equity ratios near zero. The model is asset-light (people and intellectual capital are the primary inputs, not factories), cash generation is strong, and working capital requirements are modest. These companies historically accumulated large net cash positions — meaning cash and liquid investments exceeded their minimal borrowings. For IT companies, measuring D/E is almost a formality; the more interesting question was what management was doing with the excess cash (dividends, buybacks, or acquisitions).

FMCG: minimal debt

Leading fast-moving consumer goods companies — Hindustan Unilever, Nestle India, Britannia, Dabur, Marico — similarly operated with very low or zero net debt historically. Strong operating cash generation, brand-driven pricing power, and low capex requirements meant these companies historically had no need to borrow for growth. Their balance sheets were clean, which reinforced the quality premium their valuations historically commanded.

Manufacturing and capital goods: moderate debt

Capital-intensive manufacturing businesses — auto OEMs, cement companies, steel producers, capital goods firms — historically carried moderate debt levels. For well-run industrials, D/E in the range of 0.3–1.0 was common, reflecting debt used to fund plant and equipment investments. The quality check here was not the D/E level alone but whether the operating cash flows generated by the assets were sufficient to service the debt comfortably.

Infrastructure and utilities: higher debt, matched to cash flows

Infrastructure companies — particularly in power generation, transmission, toll roads, and renewable energy — historically operated with D/E ratios in the 1–2 range (sometimes higher during project construction phases). The logic was that infrastructure assets generate long-duration, contracted cash flows (power purchase agreements, toll concession agreements) that can predictably service long-term project debt. The key risk is execution delay during construction and changes in regulatory tariffs post-commissioning.

NBFCs and housing finance companies: high D/E by design

Non-Banking Financial Companies (NBFCs) and housing finance companies are unique: borrowing money and on-lending it at a spread is their core business model. D/E ratios historically in the 4–7x range were not a sign of distress but a reflection of normal operating leverage for a lending business. The appropriate risk metrics for NBFCs are different from those for industrial companies — capital adequacy ratios (Tier 1 and total capital adequacy under RBI norms), asset quality ratios (gross and net NPA), and net interest margins matter more than the aggregate D/E in isolation.

Zero-debt companies and their appeal

A company with zero financial debt occupies a structurally advantageous position. It has:

• No interest expense, which immediately improves net profit margin relative to an otherwise identical leveraged peer.
• No refinancing risk — the risk that debt must be rolled over at higher rates or cannot be refinanced at all during a credit tightening cycle.
• Flexibility to borrow in the future if a large acquisition or expansion opportunity arises, from a position of balance sheet strength rather than necessity.
• Greater resilience during economic downturns when revenues can compress sharply — the absence of a fixed interest burden provides a buffer.

In India's equity markets, "zero-debt" or "debt-free" has historically been a screener keyword that attracted particular interest from retail investors, especially in small and mid-cap segments. The appeal is understandable: the financial resilience of a zero-debt company is genuinely higher. However, zero debt is not always optimal — a company that can borrow at 9% and deploy capital at 20% ROCE is leaving value on the table by refusing to use debt. Debt is a tool; whether it is used wisely is what matters.

When high debt is acceptable

Financial leverage amplifies both upside and downside. High debt can be appropriate — even value-creating — under the right conditions:

• Predictable, contracted cash flows. If a business generates revenues under long-term contracts (power purchase agreements, government concession agreements, long-term supply contracts), debt can be structured to match the cash flow profile. The leverage is not speculative — it is matched funding.
• Low interest rates relative to asset returns. When the cost of debt is substantially below the ROCE of the assets being funded, leverage creates a positive spread for equity holders. The 2015–2019 period in India saw relatively lower rates, which made leverage more benign for many businesses.
• Temporary construction or investment phase. A company building a new plant or expanding capacity may carry elevated debt during the investment phase, with the expectation that cash flows from the completed asset will reduce leverage over time. The critical question is whether the project delivers the expected cash flows on schedule.
• Capital recycling businesses. Real estate developers, for example, borrow to fund project construction and repay from project cash flows. D/E fluctuates with the project cycle rather than being a static measure of structural leverage.

The interest coverage ratio: the essential companion metric

Interest Coverage Ratio = EBIT ÷ Interest Expense

Debt-to-equity tells you how much debt exists relative to equity. The interest coverage ratio tells you whether the business can comfortably pay the interest on that debt. The two metrics answer different questions and should always be read together.

A company with D/E of 1.5 but interest coverage of 8x is in a very different position from a company with D/E of 1.0 but interest coverage of 1.5x. The first company carries more absolute leverage but earns its interest eight times over; it has substantial financial flexibility. The second company barely covers its interest expense — any revenue shortfall or cost increase could push it into financial stress.

Historically, Indian analysts and credit rating agencies used interest coverage thresholds as indicators of financial health:

• Coverage above 4–5x was typically considered comfortable for most industrial sectors.
• Coverage between 2–4x was considered moderate — serviceable, but with limited buffer against downturns.
• Coverage below 1.5x was historically a warning signal, indicating that earnings were barely sufficient to service interest obligations before any capital repayment.

The interest coverage ratio also appears in debt covenants for Indian corporate bonds and bank loans — lenders historically required borrowers to maintain minimum coverage ratios. A breach of these covenants could trigger early repayment clauses, adding another dimension of risk for highly leveraged companies.

How debt sits on the balance sheet

Understanding what type of debt a company carries is as important as its total quantum:

Long-term vs short-term debt

Long-term borrowings (maturity beyond one year) are typically disclosed separately from short-term borrowings (including the current portion of long-term debt due within twelve months) on the balance sheet. A company with a large proportion of short-term debt faces refinancing risk — if credit conditions tighten, rolling over that short-term paper at acceptable rates may not be possible. Long-term debt provides more stability in the funding structure.

Secured vs unsecured debt

Secured debt is backed by specific collateral — typically fixed assets like property, plant, or equipment. Lenders have a first claim on those assets in the event of default. Unsecured debt (debentures, commercial paper, inter-corporate deposits) carries no such specific charge. For a company under financial stress, the presence of large secured debt means secured lenders would recover first, leaving equity holders and unsecured creditors at greater risk. The notes to accounts in the annual report disclose the security particulars of major borrowings.

Fixed-rate vs floating-rate debt

Fixed-rate debt carries an interest rate set at origination that does not change with market rates. Floating-rate debt (typically linked to a benchmark like the repo rate or MCLR) reprices as market rates change. The distinction matters significantly during rate cycles — something the 2022–23 period in India illustrated clearly.

Net debt: a more precise leverage measure

Net Debt = Total Borrowings − Cash and Cash Equivalents (and liquid investments)

Gross debt can overstate leverage for companies that hold significant cash balances. Net debt represents the effective obligation — the amount that would remain if the company used its liquid assets to repay borrowings.

For Indian IT majors — which historically accumulated large cash balances from years of strong FCF generation — gross debt may have appeared as a small but non-zero number (from minor credit lines or lease obligations), but net debt was negative (net cash). Expressing leverage as net debt-to-equity or net debt-to-EBITDA was historically the more meaningful representation for these companies.

Net debt-to-EBITDA is also widely used across sectors as a leverage metric: it tells you how many years of operating cash generation (proxied by EBITDA) would be needed to repay net debt. A ratio below 2.0x is generally considered conservative for industrial businesses; above 4.0x was historically associated with elevated credit risk for non-financial companies.

The 2022–23 RBI rate cycle and its impact on leveraged companies

In April 2022, the Reserve Bank of India's repo rate stood at 4.0% — the level it had held since May 2020 as a pandemic-era accommodation measure. Over the following ten months, the RBI raised the repo rate six consecutive times, bringing it to 6.5% by February 2023. This 250 basis point increase was the fastest rate tightening India had seen in years.

The differential impact across the corporate universe was significant. For large companies with long-term, fixed-rate debt, the immediate impact was minimal — those borrowings did not reprice until maturity. For companies heavily reliant on floating-rate bank credit or on short-term market instruments (commercial paper, NCDs maturing within 12 months), the rate increase flowed through to their interest costs within one to two quarters.

NBFCs and housing finance companies were particularly exposed. Their business model involves borrowing at short to medium tenors (from banks, mutual funds, and capital markets) and lending at longer tenors. When short-term borrowing costs rose rapidly, net interest margins — the spread between lending rates and funding costs — came under pressure. Companies with higher D/E, weaker ALM (asset- liability management), or greater dependence on market borrowings experienced more compression than those with diversified, longer- dated liability profiles. This episode historically illustrated why interest coverage and debt tenor analysis matter alongside the headline D/E number.

This leverage risk is closely connected to the ROE dynamics discussed in our guide on ROE vs ROCE. The ROE-ROCE gap — where a company's ROE is significantly above its ROCE — often flags exactly the kind of leverage that becomes expensive when rates rise.

Reading debt on the annual report balance sheet

On an Indian company's Ind AS balance sheet, borrowings appear in two places: under Non-current liabilities(long-term borrowings) and Current liabilities(short-term borrowings and the current portion of long-term borrowings due within the year).

The notes to the borrowings line item — typically numbered in the mid-teens in most annual reports — contain a schedule of all individual loans with the lender name, outstanding balance, interest rate, security description, and repayment terms. Reading this note gives a full picture of the debt maturity profile and helps assess refinancing risk, the proportion of fixed vs floating rate debt, and any significant covenants.

Our guide on reading an annual report covers how to navigate the notes to accounts in detail, including how to find the borrowings schedule and related disclosures.

Where to go next

Leverage analysis sits at the intersection of the balance sheet, the P&L (interest expense and coverage), and the cash flow statement (debt repayments in the financing section and operating cash generation). Our guide on reading the cash flow statement explains how to trace debt repayments and cash generation through the statement. And for the return ratios that determine whether leverage is value-creating or destructive, revisit ROE and ROCE explained.

For valuation context — particularly how leverage affects the P/E ratio versus enterprise-value multiples — our P/E ratio guide discusses why EV/EBITDA is often preferred over P/E for comparing companies with different capital structures.

This article is educational only and does not constitute investment advice or a recommendation to act on any security. All references to Indian companies, historical examples, and sector norms are illustrative and reflect past conditions; past performance and historical patterns are not indicative of future results. Stock markets carry risk, including the loss of principal. Please consult a SEBI-registered investment adviser before making any investment decision.