Which metric would you look at to assess whether a company is over-levered?

Which metric would you look at to assess whether a company is over-levered?

• A. Dividend yield
• B. Interest coverage ratio
• C. Current ratio
• D. Price-to-earnings ratio

Answer: (B)

When you want to know if a company is over-levered, you focus on whether earnings can cover the cost of its debt. The interest coverage ratio does exactly that by showing how many times earnings (EBIT) can pay the interest expense. A higher number means a comfortable cushion; a low number signals that debt service is squeezing profits and could lead to trouble if earnings dip. A common rule of thumb is that a ratio below about 1.5–2 is concerning, though norms vary by industry. This ratio directly assesses debt service capability, which is why it’s the best indicator of being over-levered. Dividend yield reflects cash paid to shareholders, not debt burden. The current ratio measures short-term liquidity, not long-term leverage. The price-to-earnings ratio is a valuation metric, not a measure of debt obligations.

When you want to know if a company is over-levered, you focus on whether earnings can cover the cost of its debt. The interest coverage ratio does exactly that by showing how many times earnings (EBIT) can pay the interest expense. A higher number means a comfortable cushion; a low number signals that debt service is squeezing profits and could lead to trouble if earnings dip. A common rule of thumb is that a ratio below about 1.5–2 is concerning, though norms vary by industry.

This ratio directly assesses debt service capability, which is why it’s the best indicator of being over-levered. Dividend yield reflects cash paid to shareholders, not debt burden. The current ratio measures short-term liquidity, not long-term leverage. The price-to-earnings ratio is a valuation metric, not a measure of debt obligations.