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CFA Level I Exam · Financial Analysis Techniques

Solvency and Coverage Ratios for CFA Level I

Updated 7 October 2026 · Fact-checked

Solvency ratios measure how much debt a company uses and whether it can meet long-term obligations. Leverage ratios (debt-to-equity, debt-to-capital, financial leverage) compare debt or assets with funding. Coverage ratios (interest coverage, fixed charge coverage) compare earnings with financing costs. Pick the formula, use the right inputs, then interpret the result.

Understand Solvency and Coverage Ratios

Solvency is a company's ability to meet its long-term obligations. A firm can be liquid today and still be insolvent if its debt load is too heavy for its earnings. Solvency ratios help you judge that risk.

There are two families. Leverage ratios look at the balance sheet. They show how much of the firm's funding comes from debt. Coverage ratios look at the income statement. They show how many times earnings can pay the financing costs.

The three leverage ratios on the exam differ only in the denominator. Debt-to-equity divides debt by equity. Debt-to-capital divides debt by debt plus equity, so it can never exceed 1 if debt and equity are positive. Debt-to-assets divides debt by total assets. The financial leverage ratio is different: it is average total assets divided by average total equity, so it is not a debt ratio at all. It is the leverage term in DuPont analysis.

Higher leverage ratios mean more risk, because debt carries fixed payments. Higher coverage ratios mean more safety. A firm with interest coverage of 8 times has plenty of room if earnings fall. A firm at 1.2 times has almost none.

Ratios need context. Compare a company with its own history and with peers in the same industry. Utilities can carry more debt than software firms because their cash flows are steadier. Also check how total debt is defined. The curriculum defines it as short-term debt, the current portion of long-term debt and long-term debt.

Key formulas to remember

Debt-to-assets ratio
Total debt ÷ Total assets
Total debt means interest-bearing borrowings, not all liabilities.
Debt-to-capital ratio
Total debt ÷ (Total debt + Total shareholders' equity)
Capital is debt plus equity. Result is between 0 and 1 when both are positive.
Debt-to-equity ratio
Total debt ÷ Total shareholders' equity
Can be above 1. Equity is book value.
Converting between the two
D/E = (D/C) ÷ (1 − D/C); D/C = (D/E) ÷ (1 + D/E)
Handy when a question gives one ratio and asks for the other.
Financial leverage ratio
Average total assets ÷ Average total equity
Also called the equity multiplier. It uses all assets, not just debt.
Interest coverage
EBIT ÷ Interest payments
Uses earnings before interest and taxes. Interest is the financing cost, not net income.
Fixed charge coverage
(EBIT + Lease payments) ÷ (Interest payments + Lease payments)
Adds lease payments to both top and bottom.

How to solve Solvency and Coverage Ratios questions

Use this method for any solvency or coverage question.

  1. 1Identify what is asked: a leverage ratio (balance sheet) or a coverage ratio (income statement). Note the exact name.
  2. 2Write the formula before touching numbers. Check whether the denominator is equity, capital (debt plus equity) or average equity.
  3. 3Pull the correct inputs. Total debt means borrowings only. Use EBIT, not net income, for coverage ratios.
  4. 4For fixed charge coverage, add lease payments to the numerator and to the denominator.
  5. 5Calculate and keep at least two or three decimals until the end.
  6. 6Check the answer for sense: debt-to-capital must be below 1, and fixed charge coverage must be lower than interest coverage when coverage is above 1.
  7. 7Interpret if asked: higher leverage means more risk, higher coverage means more safety, and compare with peers.

Quickest way: Denominator check and conversion shortcut

When to use it: Use it when the question gives one leverage ratio and asks for another, or when you must rule out two options fast.

  1. Remember that debt-to-capital has the same numerator as debt-to-equity but a bigger denominator. So D/C is always smaller than D/E.
  2. If the question gives D/E, use D/C = (D/E) ÷ (1 + D/E). If it gives D/C, use D/E = (D/C) ÷ (1 − D/C).
  3. Eliminate any option for debt-to-capital that is above 1.
  4. For fixed charge coverage, compute interest coverage first. The correct answer must sit below it when coverage exceeds 1, because adding the same amount to top and bottom pulls the ratio toward 1.
  5. Use the calculator only for the final division: key the numerator, press ÷, key the denominator, press =. This works the same on the TI BA II Plus and HP 12C (press ENTER instead of = on the HP 12C).

Common mistakes in Solvency and Coverage Ratios

  • Mixing up the denominators of debt-to-equity and debt-to-capital.

    Both ratios use debt on top and the names sound alike.

    Fix: Say it aloud: capital means debt plus equity. Debt-to-capital must be below 1; debt-to-equity can be higher.

  • Using net income instead of EBIT in interest coverage.

    Net income is the most visible earnings figure and students grab it.

    Fix: Interest coverage is EBIT ÷ interest. Net income is already after interest, so it would understate the cushion.

  • Forgetting to add lease payments to the numerator of fixed charge coverage.

    Students add leases to the denominator only.

    Fix: Add lease payments in both places: (EBIT + leases) ÷ (interest + leases).

  • Treating the financial leverage ratio as a debt ratio.

    The word leverage suggests debt over something.

    Fix: It is average total assets ÷ average total equity. It is the DuPont leverage term and uses all assets.

  • Counting all liabilities as debt.

    Total liabilities is a single line on the balance sheet, so it is tempting.

    Fix: Use only interest-bearing borrowings: short-term debt, current portion of long-term debt and long-term debt. Exclude payables and accruals unless the question says otherwise.

  • Judging a ratio without a benchmark.

    Students treat a number as good or bad in isolation.

    Fix: Compare with the company's history and with peers in the same industry before concluding that solvency is strong or weak.

Worked examples

Example 1

A company reports total debt of €300 million and total shareholders' equity of €500 million. What is its debt-to-capital ratio? A) 0.375 B) 0.60 C) 1.67

Show the solution
  1. Write the formula: debt-to-capital = debt ÷ (debt + equity).
  2. Capital = 300 + 500 = €800 million.
  3. Debt-to-capital = 300 ÷ 800 = 0.375.
  4. Check the traps: 0.60 is 300 ÷ 500, which is debt-to-equity. 1.67 is 500 ÷ 300, which is equity over debt.
  5. Cross-check with the shortcut: D/E = 0.60, so D/C = 0.60 ÷ 1.60 = 0.375.

Answer: A) 0.375

Example 2

A company has EBIT of $240 million, interest payments of $40 million and lease payments of $20 million. What is its fixed charge coverage ratio? A) 4.00 B) 4.33 C) 6.00

Show the solution
  1. Write the formula: (EBIT + lease payments) ÷ (interest + lease payments).
  2. Numerator = 240 + 20 = 260.
  3. Denominator = 40 + 20 = 60.
  4. Ratio = 260 ÷ 60 = 4.33 times.
  5. Check the traps: 6.00 is interest coverage (240 ÷ 40). 4.00 is 240 ÷ 60, which leaves leases out of the numerator.
  6. Sense check: 4.33 is below 6.00, as expected.

Answer: B) 4.33

Exam tips

  • Questions are three-option MCQs with numerical options in ascending order. Distractors are usually a wrong denominator or a missing lease term, so compute the right formula first and then match.
  • Know which ratio is which by the denominator: equity, capital (debt plus equity) or total assets. Write it down before you calculate.
  • Expect conceptual items too, such as which ratio rises when a firm issues debt to buy back shares. Debt-to-equity and debt-to-capital both rise, and interest coverage falls.
  • The financial leverage ratio uses averages of total assets and total equity. If a question gives only year-end figures, use what is given and do not invent averages.
  • There is no penalty for wrong answers. If time is short, eliminate any debt-to-capital option above 1 and then guess.

Practice questions from Financial Analysis Techniques

Solvency and Coverage Ratios in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Solvency and Coverage Ratios: frequently asked questions

What is the difference between debt-to-equity and debt-to-capital?

Both use total debt on top. Debt-to-equity divides by shareholders' equity, while debt-to-capital divides by debt plus equity. So debt-to-capital is always smaller and stays below 1 when debt and equity are positive.

How do you calculate the interest coverage ratio?

Divide EBIT by interest payments. A result of 5 means EBIT covers interest five times. Higher is safer, and you should compare it with peers and the company's own history.

What is the financial leverage ratio formula in CFA Level I?

It is average total assets divided by average total equity. It is also called the equity multiplier and is a component of the DuPont decomposition of return on equity. It is not the same as debt-to-equity.

Why is fixed charge coverage lower than interest coverage?

Fixed charge coverage adds lease payments to both the numerator and the denominator. When coverage is above 1, adding the same amount to both pulls the ratio toward 1, so it falls below interest coverage.