Interest Coverage Ratio: Formula, Analysis & More

It is essential to compare the ICR of a company with industry benchmarks and historical data to assess its relative performance. Factors that can affect a company’s ICR include its level of debt, its earnings, and the rate of interest it pays on its debt. The ICR is profit before interest and tax divided by the interest charge.

  • Coverage ratios are also valuable when looking at a company in relation to its competitors.
  • Gearing ratios are an integral part of a business’s ability to repay loans and interest payment.
  • In short, it indicates the level of safety that a company has for debt interest repayment.

For companies with historically more volatile revenues, the interest coverage ratio may not be considered good unless it is well above three. The second measure considers the importance of cash flow adjustments with depreciation and amortization costs. As depreciation and amortization are simply accounting adjustments and do not involve the cash outflow, therefore, it is a realistic approach to deduct the figures from the profits. The EBITDA figure would include better ratio as it would include the cash flow statement adjustments of depreciation and amortization. Leverage ratios are important tools for measuring a company’s financial health and risk.

He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. Graham believed the interest coverage ratio to be a part of his «margin of safety.» He borrowed the term from engineering. For instance, when a 30,000-pound-capacity bridge is constructed, the developer may say that it is built for only 10,000 pounds. Suppose we want to look at the Interest coverage ratio of Manappuram Finance Ltd. for the last 5 years.

What is a Good Interest Coverage Ratio?

A way of measuring your company’s ability to meet these fixed charges is the fixed charge coverage ratio (FCCR), an expanded but more conservative version of the times interest earned ratio. The interest coverage ratio provides important information about a business’s gearing level. The ratio also offers insights about the business’s ability to meet the financial expenses against its operating profits. As the ratio includes cash out flows in the denominator it would be appropriate to use a cash flow adjusted figure like EBITDA as the numerator. The interest coverage ratio should be used to analyze the historic performance of the business with trends or change in the ratio over the years. A Coverage Ratio is any one of a group of financial ratios used to measure a company’s ability to pay its financial obligations.

This indicates that AshCali Inc is in decent financial health, with an ability to cover the interest on its outstanding debt 2.13 times using its’ earnings (signifying positive creditworthiness for the organization). Many factors go into determining these ratios, and a deeper dive into a company’s financial statements is often recommended to ascertain a business’s health. Higher ratios are better for companies and industries that are susceptible to volatility. But lower coverage ratios are often suitable for companies that fall in certain industries, including those that are heavily regulated.

Interest Coverage Ratio Explained: Formula, Examples

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The Importance of the Interest Coverage Ratio

So generally speaking, the higher the operating leverage ratio, the better. For example, a company with earnings before interest and taxes of $20 million and interest expense of $5 million would have interest coverage of 4 times. The debt-to-equity ratio focuses solely on the equity portion, while debt-to-capital ratio considers both debt and equity in the calculation. Debt-to-equity ratio highlights the relationship between debt and equity, while debt-to-capital ratio provides a broader view of a company’s overall capital structure. is an independent, advertising-supported publisher and comparison service.

The examples and/or scurities quoted (if any) are for illustration only and are not recommendatory. Using ICR alone will not help you compare two companies reliably especially if they belong to two different industries. Moreover, while calculating the interest coverage ratio, a company may not include all types of debt which might generate cost-volume-profit relationships a skewed result. Listed companies are required to publish their financial statements after every financial quarter and year. If you’re interested to check a company’s ICR, you can go through these financial statements to get the details for calculating this ratio. There are mainly two ways by which you can increase the ICR of your company.

Lenders look at the fixed charge coverage ratio to understand the amount of cash flow a company has for debt repayment. If the ratio is low, lenders see it as bad news for a company looking to take on additional debt because any drop in earning could be dire. If the ratio is high, it indicates the company is more efficient and more profitable and may be looking to borrow for growth rather than to compensate for a bad period. The interest coverage ratio is also called as times interest earned ratio. It is one of the financial analysis techniques or tools that measure of the ability of a business to pay interest on the debts against its earnings. It offers an insight to the number of times a business is able to repay interest expenses from its earnings.

What is Interest Coverage Ratio?

Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master’s in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses.

A company’s interest coverage ratio is an indicator of its financial health and well-being. Coverage refers to the length of time—ordinarily the number of fiscal years—for which interest payments can be made with the company’s currently available earnings. The Interest Coverage Ratio measures a company’s ability to meet required interest expense payments related to its outstanding debt obligations on time. A higher debt-to-EBITDA ratio indicates decreased financial stability, all else equal.

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The higher the number, the better the debt position of the firm, similar to the times interest earned ratio. When this ratio is lower than 1.5 or equal then its ability to meet interest expenses is doubtful. 1.5 is considered as the minimum acceptable coverage ratio for a company. If it is below 1.5 then the lenders are likely to refuse to lend to the company more money as the company’s risk for default becomes high.

Financial analysts and investors use the interest coverage ratio to understand a company’s ability to pay off the accumulated interest on debt. It is a powerful indicator of a company’s financial health and current debt burden. The interest coverage ratio (ICR) is a financial metric that measures a company’s ability to pay its interest expenses. It is calculated by dividing the company’s earnings before interest and taxes (EBIT) by its interest expense.

The interest coverage ratio is a financial metric that measures whether companies can pay their outstanding debts. The general rule is that the higher the ratio, the better position a company has to repay its interest obligations while lower ratios point to financial instability. Analysts generally look for ratios of at least two (2) while three (3) or more is preferred. Hence, it is required to find a financial ratio to link earnings before interests and taxes with the interest the company needs to pay.

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