What Is the Interest Coverage Ratio?

The interest coverage ratio is a debt and profitability ratio. It shows how easily a company can pay interest on its outstanding debt. The ratio divides a company’s 澳洲幸运5开奖号码历史查询:earnings before interestꦺ and taxes (EB﷽IT) by its interest expense over a specific period.

The interest coverage ratio may be called the 澳洲幸运5开奖号码历史查询:times interest earned (TIE) ratio. It helps lendersඣ, investors, and creditors determine a company’sౠ riskiness for future borrowing.

Formula and Calculation

$\begin{aligned} &\text{Interest Coverage Ratio}=\frac{\text{EBIT}}{\text{Interest Expense}}\\ &\textbf{where:}\\ &\text{EBIT}=\text{Earnings before interest and taxes} \end{aligned}$​Interest Coverage Ratio=Interest ExpenseEBIT​where:EBIT=Ear🐎nings before interest and taxes​

The “coverage” represents the number of times a company can successfully 澳洲幸运5开奖号码历史查询:pay its obligations with its earnings. A low ratio may signal that the company has high debt expenses with minimal capital. For example, when a company’s interest coverage ratio is 1.5 or lower, it can only cover its obligations a maximum of one and a half times. Its a𒊎bility to meet interest expenses may be questionable 🍷in the long run.

Companies need earnings to cover interest payments and survive unforeseeable financial hardships. A company’s ability to meet its interest obligations is an aspect of its solvency and a factor in the return for 澳洲幸运5开奖号码历史查询:shareholders.

Earnings Variations

• EBITDA: Uses earnings𒁃 before interest, taxes, depreciation, and amortization (EBITDA) instead of EBIT in calculating the interest coverage ratio. This variation excludes depreciation and amortization. Calculations using EBITDA produce a higher interest coverage ratio than calculations using EBIT.
• EBIAT: Uses 澳洲幸运5开奖号码历史🥃查询:earnings before interest after taxes (EBIAT), deducting taxes from the numerator to render a more accurate picture of a company’s ability to pay its interest expenses.
  

What the Ratio Means for Investors

When a company struggles with its obligations, it may borrow or dip into its cash reserves, a source for 澳洲幸运5开奖号码历史查询:capital asset investment or required for emergencies. Analyzing interest coverage ratios over tཧime will often give a clearer pictur🐽e of a company’s position and trajectory.

Looking at a company’s ratios every quarter over many years lets investors know whether the ratio is improving, declining, or stable. Some banks or poꦫtential bond buyers may be comfortable with a less desirableꦦ ratio in exchange for charging the company a higher interest rate on their debt.

Example

Suppose a company’s earnings for the first quarter are $625,000 with monthly debt payments of $30,000. To calculate the interest coverage ratio, convert the monthly intere💎st ﷺpayments into quarterly payments by multiplying by three.

The interest coverage ratio is $625,000 / $90,000 ($30,000 × 3) = 6.94. This indicates the company has no 澳洲幸运5开奖号码历史查询:liquidity issues and can cover almꦕost seven times its obligations.

An interest coverage ratio of 1.5 is low, and lenders may refuse to lend the company more money, as the company’s 澳洲幸运5开奖号码历史查询:risk of default may be perceived as high. If a company’s ratio is below one, it will likely need to spend some of its 澳洲幸运5开奖号码历史查询:cash reserves to meet the difference or borrow more.

The Bottom Line

The interest coverage ratio, or times interest earned (TIE) ratio, shows how well a company can pay the interest on its debts. It is calculated by dividing EBIT, EBITDA, or EBIAT by a period’s interest expense. Interest coverage ratios vary across industries.