Debt increases more than opportunity
IAS 32 considers the contractual substance of financial liabilities and equity, while IFRS 16 covers recognition of certain lessee lease liabilities. The definition of analytical debt must therefore state how leases and other components are treated. Numerators with different composition cannot be compared merely because both tables are labelled “debt”.
Earnings coverage in a simple model
A fictional business has operating profit before interest of 150 and interest expense of 30. Interest coverage is 150 / 30 = 5. If operating profit falls to 75 with the same interest, the ratio becomes 2.5. In both cases earnings still exceed interest, but sensitivity to weaker operations differs materially.
Now add principal repayment of 100 and separately specified cash available before debt service of 90. Required payments in the model are 30 + 100 = 130; the shortfall is 40. Five-times earnings coverage in the first scenario does not close this calendar gap. Principal repayment and the mismatch between earnings and cash are not captured by earnings-to-interest alone.
Gross and net debt describe different things
If a company has debt of 300 and cash of 100, the simple analytical difference is 200. But deducting all cash depends on its availability and operating needs. Restricted funds, cash belonging to another group participant and a required working balance may not be free resources for repaying the selected debt. Keep gross and net figures together with an explanation of the deductions.
Negative net debt does not mean no risk. Timing of receipts and payments, currency, transferability and unexpected obligations still matter. One net number hides the volume of creditor contracts. It can help with some comparisons, but it does not replace a calendar and liability composition.
The denominator is not unambiguous
Debt-to-EBITDA is sensitive to the definition of both measures. Excluding one-off costs, leases or other items can materially change the result. If the denominator is near zero or negative, the usual scale loses stable meaning. Describe absolute burden and cash scenarios instead of ranking companies by a formally smaller negative ratio.
A common mistake is to apply one “normal debt” level to a bank, retailer and capital-intensive manufacturer. Another is to treat interest as the only mandatory payment while ignoring leases, principal repayment and necessary investment. Label which resource and burden each calculation covers.
Checking the result and its limits
Build a consistent set of measures: funding structure, interest coverage, principal calendar and available-cash scenarios. IAS 7 identifies financing cash flows and shows the cash side of borrowing. Compare those flows with changes in balance-sheet debt and investigate non-cash movements.
This material does not assign a credit rating or determine a contractual breach. Related concepts include [interest coverage](/glossary/pokrytie-procentov/), [financial leverage](/glossary/kreditnoe-plecho/) and [profit versus cash](/guides/profit-vs-cash/).
Financial flexibility needs a buffer, but the buffer cannot be guessed
A company with regular contractual receipts and one with unpredictable orders may tolerate the same fixed burden differently. Examine income stability, the ability to cut costs and the timing of required investment. This does not produce a universal acceptable debt level; it explains why the same ratio has different context. Do not replace context with an industry label without data.
In a falling-result scenario, show separately which payments remain unchanged, which depend on the contract rate and which can be deferred. Do not assume complete fixity or flexibility when terms are unknown, especially where contracts have different repricing dates and currencies. A range can be more informative than one forecast interest amount.
If assets are used to repay debt, consider timing and possible sale price. A balance-sheet amount is not guaranteed cash on the required date. Selling a core operating resource can also change future earning capacity.
FCC is broader than TIE: fixed payments need a compatible resource
In the original model, TIE is EBIT / interest. Fixed-charge coverage broadens the set of mandatory payments; its composition depends on the analyst’s or contract’s definition. The Canadian BDC educational material distinguishes DSCR and fixed-charge coverage, including lease costs, and recommends confirming required inputs with the lender. This is not an IFRS formula or a universal condition of every loan.
Construct a measure based on earnings before tax. Let I be interest, L fixed lease expense already deducted in obtaining EBIT, and P principal repayment or a mandatory sinking-fund contribution not deducted from taxable earnings in the model. For a stated tax rate t and full immediate deductibility of I and L: **FCC = (EBIT + L) / (I + L + P / (1 − t)).**
L is returned to the numerator because it already reduced EBIT but is now included in the covered burden. P is converted to a pre-tax earnings equivalent: to leave 24 after a stated 20% tax, 30 is needed before tax. This follows from the explicit model and is not a universal lending methodology. At t = 1 the transformation is undefined; with losses or unusable deductions it does not describe real cash.
Let EBIT = 180, I = 30, L = 60, P = 24 and t = 20%. TIE is 6 and FCC = 240 / (30 + 60 + 30) = 2. To check FCC = 1, if EBIT + L equals 120, after lease and interest 30 remains; after the assumed tax, 24 remains, exactly enough for P. Dividing 180 by 30 + 60 + 24 would mix incompatible bases.
If P is absent, the simplified lease version is (180 + 60) / (30 + 60) = 2.67. This is a different measure and cannot be published beside 2 without labelling its composition. Other mandatory payments or EBITDA adjustments require their own compatible formula and consistent period, currency and perimeter.
IFRS 16 leases require special care: reported EBIT may contain right-of-use depreciation while lease interest is below EBIT. Adding the full cash lease payment to that EBIT under the formula above is not automatic because the assumption that L was fully deducted is not met. Reconstruct the original resource and remove double-counting. Even a correct earnings FCC does not automatically reflect sustaining investment, working-capital changes or payment dates; retain a separate cash calendar. A value above one in this educational model is not covenant compliance, a credit rating or a repayment guarantee.