Solvency Ratios: Debt-to-Equity and Debt Ratio

Solvency ratios measure a company's ability to meet its long-term debt obligations. This post covers leverage — both operating and financial — and three key solvency ratios: debt-to-equity, debt ratio, and interest coverage.

This is Part 4 of the Fundamental Analysis series. If you're new to the series, start with Liquidity Ratios, then move to Valuation Ratios and Profitability Ratios.

Types of Leverage

There are two types of leverage: operating leverage and financial leverage.

Operating leverage depends on a company's cost structure. Every company has fixed costs — expenses that remain the same regardless of how much the company produces or sells. If fixed costs are high, the company has high operating leverage.

Financial leverage shows how a company has structured its capital — what percentage comes from debt and what percentage comes from equity.

Operating Leverage

High Operating Leverage — Aviation

The aviation industry is a classic example of high operating leverage. Airlines carry heavy fixed costs: aircraft leases, insurance, crew salaries, and maintenance. In strong market conditions, airlines perform well because revenue scales while fixed costs stay constant. However, in downturns, those fixed costs do not shrink. During COVID-19, air travel stopped for months, but airlines still had to pay for leased aircraft and insurance — resulting in heavy losses.

Low Operating Leverage — Service Companies

Service-based companies such as IT consulting or staffing firms have low operating leverage. Their fixed costs — rent, utilities, and basic infrastructure — are relatively small compared to revenue. Most of their costs are variable (employee compensation tied to headcount), so they can scale expenses up or down more flexibly.

Financial Leverage

High Financial Leverage — Real Estate

Real estate development is a classic example of high financial leverage. To fund construction, real estate companies prefer to take out loans rather than use their own capital. If the market is strong and real estate is booming, these companies perform well. But when the market slows down, they still need to pay interest every year — even if they cannot sell their properties.

Low Financial Leverage — Service Companies

Service companies typically have low financial leverage. They do not need to borrow heavily because their business model relies on people and expertise rather than physical assets.

Solvency Ratios

Leverage — both operating and financial — determines how much risk a company carries through its cost structure and capital mix. Solvency ratios put a number on that risk. They measure whether a business can meet its long-term debt obligations over time.

Long-term liabilities include items such as debentures, long-term borrowings, and long-term provisions.

The three key solvency ratios are:

1. Debt-to-Equity Ratio
2. Debt Ratio
3. Interest Coverage Ratio

Debt-to-Equity Ratio

Debt-to-Equity Ratio = Total Debt / Shareholders' Equity

If a company has $5 billion in debt and $10 billion in equity, its debt-to-equity ratio is 0.5. For the same equity, if the company has $10 billion in debt, the ratio becomes 1.0. The higher the ratio, the more risk the company carries in servicing its debt.

In the banking and NBFC (non-banking financial company) industries, this ratio tends to be higher because their core business is lending — they borrow money in order to lend it out.

However, a low debt-to-equity ratio does not always mean a company is in a strong position. It can also indicate that the company relies too heavily on equity for growth or is unable to access enough debt to expand. In such cases, the company must rely on its cash reserves to fund expansion, and weak liquidity can constrain growth.

Debt Ratio

Debt Ratio = Total Debt / Total Assets

This ratio shows what proportion of a company's total assets is financed by debt. Total assets include both current and non-current assets.

If the ratio is high, it signals a risky position — a larger share of the company's assets is financed by debt rather than equity. A lower debt ratio indicates a stronger financial position, with more assets funded by equity than by borrowed capital.

Interest Coverage Ratio

Interest Coverage Ratio = EBIT / Interest Expense

This ratio shows how comfortably a company can pay interest on its debt from the profit it earns. EBIT stands for Earnings Before Interest and Taxes.

Suppose a company's EBIT is $10 billion and its interest expense is $5 billion — the interest coverage ratio is 2. A different company with the same EBIT but only $2 billion in interest expense has an interest coverage ratio of 5. The higher the ratio, the more comfortably the company can service its interest payments.

Comparing Aviation and Real Estate Companies

The financial data below is sourced from company annual reports and SEC EDGAR filings, using the latest available annual data for each company.

Delta Air Lines (DAL): FY 2025 (ending Dec 31, 2025). Revenue $63.36B, total assets $81.32B, total debt $21.37B, shareholders' equity $20.85B, EBIT $5.82B, interest expense $679M.

United Airlines (UAL): FY 2025 (ending Dec 31, 2025). Revenue $59.07B, total assets $76.45B, total debt $31.04B, shareholders' equity $15.28B, EBIT $4.71B, interest expense $1.17B.

D.R. Horton (DHI): FY 2025 (ending Sep 30, 2025). Revenue $34.25B, total assets $35.47B, total debt $5.97B, shareholders' equity $24.74B, EBIT $4.42B.

Lennar (LEN): FY 2025 (ending Nov 30, 2025). Revenue $34.19B, total assets $34.43B, total debt $4.09B, shareholders' equity $22.14B, EBIT $2.67B, interest expense $175M.

Aviation — Delta Air Lines vs. United Airlines

Both airlines carry significant debt relative to equity — typical of the capital-intensive aviation industry. United Airlines has a notably higher debt-to-equity ratio (2.03 vs. 1.02) and lower interest coverage (4.04 vs. 8.57), meaning Delta is in a stronger position to service its debt.

Real Estate (Homebuilders) — D.R. Horton vs. Lennar

Both homebuilders maintain conservative leverage. D.R. Horton and Lennar fund the majority of their operations through equity rather than debt, keeping their debt-to-equity ratios well below 1.0.

Summary

• Operating leverage depends on fixed costs — high fixed-cost industries like aviation benefit more in good times but suffer more in downturns. Financial leverage depends on how much of the capital structure comes from debt versus equity.
• Debt-to-equity measures debt relative to shareholders' equity; a higher ratio means more risk. Debt ratio shows what share of total assets is financed by debt; a higher ratio signals heavier reliance on borrowed capital.
• Interest coverage reveals whether a company earns enough operating profit to comfortably pay its interest — the higher the ratio, the safer the position.
• Always compare solvency ratios within the same industry, since capital structure varies widely across sectors.

All financial data sourced from company annual reports and SEC EDGAR filings. Delta Air Lines and United Airlines FY 2025 (Dec 2025), D.R. Horton FY 2025 (Sep 2025), and Lennar FY 2025 (Nov 2025).

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Sources and references

• Debt-to-Equity (D/E) Ratio — Investopedia
• Debt Ratio — Investopedia
• Interest Coverage Ratio — Investopedia

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This analysis is for educational purposes only and does not constitute investment advice.