Corporate debt — and not just that of giant financial institutions, which announce multi-billion-dollar loan losses almost on a daily basis — has become the market’s and investors’ overwhelming problem.

For the ordinary investor and advisor, debt becomes a major focus of investment analysis and selection as a business recession looms. Your assumptions should change. “Credit quality” is a current touchstone for investment decisions.

And because of the credit crisis, you can no longer assume that a company will be able to obtain the credit it needs.

You also cannot assume that a business’s or a bank’s owed money is going to be repaid in full and on time. Every situation should be checked.

You can’t even assume the balance sheet line “cash and cash equivalents” can be accepted at face value. Perhaps the cash equivalents include a significant flavouring of asset-backed commercial paper.

With a recession in the U.S. likely — if not already — underway, will the companies in your clients’ portfolios be able to generate the cash needed to cover interest payments? Or will they be ready to repay a major bond issue maturing in the next year or two?

Your clients will probably stop asking about earnings growth. Instead, you will need to brief them on old-fashioned investment ratios such as interest coverage and dividend coverage. As such, the earnings before interest and taxes measure will become more useful than earnings before interest, taxes, depreciation and amortization.

Some clients may ask whether it is safe to invest in companies that have long-term debt. Wouldn’t debt-free be better?

Such questions hearken to past periods when economic growth was less robust and business risk seemed higher, when investors worried about dividends and yields rather than forward price/earnings multiples and stock splits.

With more than $500 trillion in derivatives outstanding worldwide — and billions in packaged debt and mortgage securities of unknown worth in lenders’ hands — it is unlikely the credit crisis will end soon.

For one thing, the drop in U.S. housing prices that set off the crisis may have another year or two to run. The U.S. Congress’s plan to hand out cash will do little to prevent consumer spending from dropping. And earlier efforts of that type offer no hope for success this time around.

Until two years ago, the main worry in the capital markets was whether inflation would push long-term bond yields skyward. Such worries have now dropped into the background because it seems few in the capital markets want to touch debt or lend money.

The credit crisis means normally credit-worthy borrowers have difficulty obtaining money; such is the suspicion of debt default.

Most companies owe money in some form of long-term obligation. Gaining more credit will become a larger problem, so companies that can manage on the debt they already have gain a preference with investors whereas companies that must borrow become higher-risk investments.

As for companies that have almost continually added to their long-term debt — as they have been unable to grow without a debt fix almost every year — they will run into real problems. They are high-risk investments if their business model still depends on more debt under recessionary conditions.

Exceptions, of course, are utilities or utility-type industries with steady and recession-resistant income. But there are companies in a gray area of definition; so are they really recession resistant?

The long-term debt question comes down to how much debt should, or can, a company carry. The answer, like so many basic investment questions, was provided decades ago by pioneer investment analyst Benjamin Graham and his associates.

They concluded that a limited amount of long-term debt, to provide some leverage for share capital, enhances shareholder returns. That proportion is no more than about 30% of “permanent capital” with the remaining 70% being shareholders’ equity. Expressed as a debt to equity ratio, this is about 0.43.

The only time a debt-free balance sheet has appeal is in a business downturn, when cash flow can be directed solely to the survival or competitive advantage of the enterprise.

Other types of analysis will become even more valuable if a recession does develop. One is the “Z-factor” analysis, which has been used since 1983 to gauge whether a company is in financial distress or if it will likely become bankrupt. This multi-factor predictive analysis was developed by Edward I. Altman, who later headed New York University’s business school.

@page_break@Another approach is “objective economics” developed in the 1980s by the late Verne Atrill and carried on by Toronto-based Strategic Analysis Corp. , headed by Ross Healy.

Both the Altman Z-score and Atrill’s “structural valuation analysis” focus on balance-sheet data in unconventional ways to derive their answers. The Z-score formula also uses sales and EBIT. Significantly, neither analysis includes that nebulous figure called “net income.” IE