Answers the Question
How easily can we pay for our interest fees?
Calculator for Interest Coverage Ratio
What Is the Interest Coverage Ratio?
The interest coverage ratio is essentially a measure of the multiple of how much money a firm earns vs the amount of money that needs to be allocated to interest payments.
Why Is it Important?
- This measure provides a window into whether a firm will succumb to its creditors. The lower the value, the more likely that the firm will face some combination of a) increasing indebtedness b) punitive action (such as foreclosure).
- Obviously, values under 1.0 should be troubling for large and mature firms as the figure implies that the firm is likely going deeper and deeper into debt.
Formula(s) to Calculate Interest Coverage Ratio
- INTEREST COVERAGE RATIO = EBIT / INTEREST EXPENSES
- Firms that can easily pay off their interest each month may still be in dire financial situations. They may not be earning enough to pay off any of the principal, or may not be able to cover other expenses (such as labor or rent).
- It should also be noted that just because a firm can cover its interest expenses, they might choose not to do so. This may be because the firm has found better investments, or it may point to some sinister act by those controlling the company's finances.