Which financial ratios matter most in corporate credit analysis?

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AcadiFi · Accepted Answer

Credit analysis prioritizes three ratio families: leverage, coverage, and cash flow. Each captures a different dimension of default risk. LEVERAGE RATIOS 1. Debt / EBITDA - Formula: Total debt / EBITDA - IG threshold: <3.0x for BBB, <2.0x for A, <1.0x for AA+ - HY threshold: 3-5x for BB, 5-7x for B, >7x for CCC - Adjust for operating leases (capitalize), pension, guarantees 2. Net Debt / EBITDA - Subtracts cash and marketable securities - More relevant when firm has meaningful liquidity cushion - Watch for trapped offshore cash (not truly available) 3. Debt / Capital - Formula: Total debt / (Debt + Equity) - Structural view; less useful for firms with negative equity - Norms: <40% IG, 40-60% crossover, >60% HY COVERAGE RATIOS 4. EBITDA / Interest - Primary coverage metric - IG: >8x; BBB: 3-8x; BB: 2-3x; B: 1-2x - Higher is better; cushion against rate increases 5. EBIT / Interest - More conservative (strips D&A) - S&P and Moody's key metric 6. (EBITDA − Capex) / Interest - Reflects cash available after maintenance capex - Especially important for capital-intensive industries 7. FCF / Interest - Purest cash flow coverage - FCF = CFO − Capex − Dividends CASH FLOW RATIOS 8. CFO / Debt - Operating cash generation to debt load - IG: >20%; BB: 12-20%; B: 7-12% 9. FFO / Debt - Funds from Operations (CFO before working capital changes) - Moody's core metric - Same thresholds as CFO/Debt 10. FCF / Debt - Most conservative - IG: >10%; BB: 5-10%; B: <5% PEER AND TREND ANALYSIS Absolute ratios matter less than: - Peer comparison within industry - Trend over 3-5 years - Trajectory vs. rating category Worked example — Meridian Outdoor Equipment (BB rated): - Debt/EBITDA: 4.2x (vs. 3.8x peers median) - Net Debt/EBITDA: 3.8x - EBITDA/Interest: 4.5x - FFO/Debt: 15% - FCF/Debt: 6% Verdict: consistent with BB rating. Leverage slightly above peers but coverage adequate. Watch trajectory if EBITDA softens. PITFALLS - EBITDA add-backs can inflate figures (run-rate synergies, restructuring charges, stock-comp) - Rating agency adjusted metrics (S&P Adjusted Debt, Moody's Adjusted Debt) are more reliable than as-reported - Off-balance-sheet leverage (operating leases pre-ASC 842, securitizations, guarantees) - One-time windfalls boost current ratios but unsustainable

Which financial ratios matter most in corporate credit analysis?

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