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# The 15 Credit Ratios Every Investor Should Know

Credit ratios analysis provides investors and operators with a consistent framework for organizing and benchmarking numbers from a financial statement. By converting the raw financials into ratios, we can more easily spot relationships and trends across stocks. In this post, I discuss the 15 credit & balance sheet ratios that allows investors to quickly gauge a company’s credit health and management’s operating capital efficiency.

Credit ratios vary greatly by sector. I provide a table for each ratio listing the median of firms in the finbox.com database by sector so that you can benchmark your subject firm appropriately. The sector medians listed are as of November 8th, 2017. You may also find my posts on Valuation Ratios, Profit & Return Ratios, and Cash Flow Ratios helpful.

Interested in example calculations of the ratios discussed? I’ve created a spreadsheet template you can use to calculate these 15 credit ratios. The spreadsheet contains three tabs:

• Cheat Sheet: This tab lists Credit & Balance Sheet ratios and formulas used to calculate each ratio.

• [Example] Calculator: You can use this tab to calculate all the ratios discussed for any business by manually entering the financials required in designated cells colored in yellow under the "Required Data" section.

## The Top 15 Credit & Balance Sheet Ratios

###### 1. EBIT Interest Coverage

The EBIT Interest Coverage ratio is one of three popular "interest coverage ratios" used to assess a firm's ability to pay interest expenses based on operating profits. It is one of the most popular credit ratios and, as the name suggests, the EBIT Interest Coverage ratio uses earnings before interest and taxes (EBIT) in the numerator.

Formula

``````EBIT Interest Coverage = EBIT ÷ Interest Expense
``````
Median by Sector
Sector EBIT Interest Coverage
Consumer Discretionary 4.2x
Consumer Staples 5.4x
Energy 1.0x
Financials 5.3x
Healthcare -5.2x
Industrials 5.2x
Information Technology 2.3x
Materials 3.8x
Telecom 1.8x
Utilities 3.0x
###### 2. EBITDA Interest Coverage

The primary difference between the EBIT Interest Coverage ratio and the EBITDA Interest Coverage ratio is the exclusion of Depreciation and Amortization (D&A) expenses from the numerator in the latter. EBITDA Interest Coverage ratio uses earnings before interest, taxes, depreciation, and amortization (EBITDA) since depreciation and amortization represent a non-cash charge and therefore do not impact the amount of cash available to pay interest expenses.

Formula

``````EBITDA Interest Coverage = EBITDA ÷ Interest Expense
``````
Median by Sector
Sector EBITDA Interest Coverage
Consumer Discretionary 7.2x
Consumer Staples 7.8x
Energy 3.3x
Financials 7.9x
Healthcare -3.7x
Industrials 8.3x
Information Technology 6.3x
Materials 6.7x
Telecom 4.5x
Utilities 4.9x
###### 3. EBITDA - CapEx Interest Coverage

While is true that depreciation and amortization don't directly impact the cash available, a firm must eventually replace depreciable assets in order to continue operating. A variant of the EBIT Interest Coverage ratio that accounts for these requirements is the EBITDA - CapEx Interest Coverage ratio. EBITDA - CapEx is preferred over EBIT Interest Coverage when a firm is growing and needs capital expenditures to support this growth since historical D&A will underestimate its cash needs in that scenario.

Formula

``````EBITDA - CapEx Interest Coverage = (EBITDA - CapEx) ÷ Interest Expense
``````
Median by Sector
Sector EBITDA less CapEx Coverage
Consumer Discretionary 4.7x
Consumer Staples 4.6x
Energy 1.3x
Financials 7.1x
Healthcare -4.6x
Industrials 5.7x
Information Technology 4.1x
Materials 4.0x
Telecom 1.9x
Utilities 0.9x
###### 4. Debt to Equity

Capital structure is the mix of debt and equity used to finance operations and is the primary driver of credit risk. The Debt to Equity ratio is one of the key financial ratios for credit analysis, and it is the most common one used to represent capital structure. Typically, a higher Debt to Equity ratio indicates higher credit risk. This is not always the case - utility companies, real estate investment trusts and commercial banks often operate with high leverage since they commonly have cash flows that are predictable and stable.

Formula

``````Debt to Equity = Total Debt ÷ Common Equity
``````
Median by Sector
Sector Debt / Equity
Consumer Discretionary 44.7%
Consumer Staples 61.0%
Energy 59.6%
Financials 63.8%
Healthcare 4.7%
Industrials 57.8%
Information Technology 12.2%
Materials 52.1%
Telecom 63.2%
Utilities 109.3%
###### 5. Debt to Tangible Equity

Debt to Tangible Equity is a variant of the Debt to Equity ratio. Instead of common equity, tangible common equity (TCE) is used in the denominator. Tangible common equity is calculated by subtracting the value of goodwill and intangible assets from common equity. The Debt to Tangible Equity gained popularity during the 2008–2009 economic crisis since it is a stricter measure of balance sheet health for common shareholders.

Formula

``````Debt to Tangible Equity = Total Debt ÷ (Common Equity - Intangible Assets)
``````
Median by Sector
Sector Debt / Tangible Equity
Consumer Discretionary 5.9%
Consumer Staples 0.3%
Energy 63.1%
Financials 68.6%
Healthcare 0.0%
Industrials 22.5%
Information Technology 0.0%
Materials 34.2%
Telecom 0.0%
Utilities 118.2%
###### 6. Debt To Total Capital

Debt To Total Capital measures the level of the debt relative to the market value of total capital. When the market value of equity is far above the amount listed on the Balance Sheet, the Debt to Total Capital ratio provides a more accurate representation of risk and leverage. The lower the Debt to Total Capital percentage, the higher the equity cushion provided to lenders and the lower the charged interest rate.

Formula

``````Debt To Total Capital = Total Debt ÷ (Total Debt + Market Capitalization)
``````
Median by Sector
Sector Debt / Total Capital
Consumer Discretionary 22.2%
Consumer Staples 18.5%
Energy 33.2%
Financials 30.2%
Healthcare 3.9%
Industrials 18.4%
Information Technology 5.1%
Materials 20.7%
Telecom 31.7%
Utilities 37.0%
###### 7. Cash Flow to Total Debt

Cash Flow to Total Debt is used in two different useful ways - a) to measure cash flow coverage and b) to find the ratio's inverse in order to estimate the length of time needed to pay off debts if all available dollars are allocated to repayment. Here at finbox.com, we use Cash Flow from Operations reported in the Statement of Cash Flows to calculate Cash Flow to Total Debt. Some analysts nevertheless prefer to compute this ratio using EBITDA in the numerator.

Formula

``````Cash Flow to Total Debt = Cash Flow from Operations ÷ Total Debt
``````
Median by Sector
Sector Cash Flow / Total Debt
Consumer Discretionary 22.8%
Consumer Staples 24.6%
Energy 18.7%
Financials 15.9%
Healthcare -26.2%
Industrials 24.2%
Information Technology 31.7%
Materials 24.3%
Telecom 23.0%
Utilities 18.0%
###### 8. Liabilities to Assets

The Liabilities to Assets ratio (also referred to as Debt Ratio) measures the proportion of a firm's assets financed by liabilities. This ratio is similar to Debt / Equity as it measures leverage in the capital structure. A ratio greater than 0.5 indicates that the firm primarily uses credit and payables to finance assets.

Formula

``````Liabilities to Assets = Total Liabilities ÷ Total Assets
``````
Median by Sector
Sector Liabilites / Assets
Consumer Discretionary 60.6%
Consumer Staples 58.1%
Energy 53.1%
Financials 87.3%
Healthcare 41.7%
Industrials 57.9%
Information Technology 45.2%
Materials 53.2%
Telecom 70.4%
Utilities 69.4%
###### 9. Cash Ratio

The Cash Ratio is a strict ratio used to assess a company's short-term liquidity. This ratio is considered "strict" because it only uses cash and short-term investments as sources of liquidity to service liabilities.

Formula

``````Cash Ratio = (Cash & ST Investments) ÷ Current Liabilities
``````
Median by Sector
Sector Cash Ratio
Consumer Discretionary 0.4x
Consumer Staples 0.2x
Energy 0.4x
Financials 0.1x
Healthcare 2.3x
Industrials 0.3x
Information Technology 0.9x
Materials 0.5x
Telecom 0.4x
Utilities 0.1x
###### 10. Quick Ratio

The Quick Ratio is used to assess a company's short-term liquidity. This ratio is more relaxed than the Cash Ratio, but still only considers cash, short-term investments like marketable securities, and receivables which can all be "quickly" converted into cash at their book values as sources of liquidity.

Formula

``````Quick Ratio = (Cash & ST Investments + Receivables) ÷ Current Liabilities
``````
Median by Sector
Sector Quick Ratio
Consumer Discretionary 0.8x
Consumer Staples 0.7x
Energy 1.0x
Financials 0.1x
Healthcare 2.8x
Industrials 1.2x
Information Technology 1.5x
Materials 1.3x
Telecom 0.9x
Utilities 0.5x
###### 11. Current Ratio

The Current Ratio is also used to assess a company's short-term liquidity. Unlike the Quick Ratio, this ratio considers all current assets as sources of liquidity. Current assets represent the assets a firm expects to convert to cash over the next 12 months. Current liabilities represent the obligations a firm must pay with cash over the next 12 months. In the event of distress, some of the current assets may not be available to be converted into cash at their carrying values. For example, if there is little demand for a firm's inventory, the carrying value may be overstated. Likewise, current assets like prepaid insurance, prepaid legal expenses, and office supplies can be difficult to convert into cash.

Formula

``````Current Ratio = Current Assets ÷ Current Liabilities
``````

The popular Piotroski Score uses the Current Ratio and awards a point when the change in Current Ratio is greater than zero.

Median by Sector
Sector Current Ratio
Consumer Discretionary 1.6x
Consumer Staples 1.5x
Energy 1.3x
Financials 1.0x
Healthcare 3.4x
Industrials 1.8x
Information Technology 2.0x
Materials 2.3x
Telecom 1.1x
Utilities 0.9x
###### 12. Asset Turnover

Asset Turnover represents the dollars in revenue that a company generates per dollar of assets. Asset Turnover is typically used to measure the efficiency of a firm and its management at deploying capital for assets that yield revenue. Note that we use average Total Assets from the start and end of the year in the denominator, since sales are made over the course of a year.

Formula

``````Asset Turnover = Sales ÷ Average Total Assets
``````

The Asset Turnover ratio is also a component of the Piotroski Score. The Piotroski Score awards a point to stocks with increasing Asset Turnover.

Median by Sector
Sector Asset Turnover
Consumer Discretionary 1.1x
Consumer Staples 1.0x
Energy 0.3x
Financials 0.1x
Healthcare 0.3x
Industrials 0.9x
Information Technology 0.8x
Materials 0.7x
Telecom 0.5x
Utilities 0.3x
###### 13. Fixed Asset Turnover

The Fixed Asset Turnover ratio measures how well a firm uses its fixed assets to generate revenues. While fixed assets like plant, property, and equipment aren't consumed directly in a sale-like inventory, they’re still assets that are necessary to sustain operations. Consequently, it's important to measure how well management is purchasing capital assets to generate revenue.

Formula

``````Fixed Asset Turnover = Sales ÷ Average Net Property, Plant, and Equipment
``````
Median by Sector
Sector Fixed Asset Turnover
Consumer Discretionary 6.3x
Consumer Staples 5.5x
Energy 0.4x
Financials 5.1x
Healthcare 4.2x
Industrials 6.1x
Information Technology 11.1x
Materials 1.8x
Telecom 1.2x
Utilities 0.4x
###### 14. Inventory Turnover

The Inventory Turnover ratio illustrates how many times a firm's inventory is sold and replaced over the course of a year. A declining Inventory Turnover ratio can be a leading indicator of pricing pressure and sales slumps.

Formula

``````Inventory Turnover = COGS ÷ Average Inventory
``````
Median by Sector
Sector Inventory Turnover
Consumer Discretionary 8.7x
Consumer Staples 9.3x
Energy 20.1x
Financials NM
Healthcare 7.8x
Industrials 8.0x
Information Technology 8.7x
Materials 7.2x
Telecom NM
Utilities NM
###### 15. Cash Conversion Cycle

Cash Conversion Cycle is a metric that compares the number of days it takes a company to sell inventory and collect receivables relative to the number of days afforded to pay bills. It attempts to measure the time between the outflow and inflow of cash in the sales cycle. A negative figure suggests that the firm can receive payments for product sales before having to pay suppliers.

Formula

``````Cash Conversion Cycle =
Days Sales Outstanding
(+) Days Inventory Outstanding
(-) Days Payable Outstanding
``````
Median by Sector
Sector Cash Conversion Cycle
Consumer Discretionary 38 days
Consumer Staples 50 days
Energy 10 days
Financials -NM
Healthcare 67 days
Industrials 61 days
Information Technology 46 days
Materials 62 days
Telecom -19 days
Utilities 18 days

In this article, you've discovered the key financial ratios for credit analysis. To make sure you don't forget any of them, I’ve created a simple [cheat sheet](https://drive.google.com/file/d/0B_SVUm8NVYx_U1VjcXdadXFrcGc/view" target="_blank)) listing the formulas and short descriptions that you can download and print for quick reference.

If you find this article interesting, you may also like this one: [Balance Sheet Analysis: 10 Ratios You Should Use](/blog/balance-sheet-analysis-10-ratios-you-should-use/" target="_blank). In this article, you will learn what balance sheet ratios should you use, why they are important, how they affect your investment returns, and how you can use them to optimize your portfolio.

### Andy Pai

Founder @ finbox.io. We build tools that make life easier for investors. I started my career in investment banking. I live in Chicago. Reach out if I can be helpful!

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