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官方开奖结果体彩网:earni🤡ngs before inter✅est and taxes (EBIT) by its interest expense over a specific period.

The interest coverage ratio may be called the 澳洲幸运5官方开奖结果体彩网:times interest earned (TIE) ratio. It helps lenders, investors, and creditors determine a company’s riskiness for f🍬uture borrow⭕ing.

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&🧸nbsp;taxes​

The “coverage” represents the number of times a company can successfully 澳洲幸运5官方开奖结果体彩网: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 rat🧸io is 1.5 or lower, it can only cover its obligations a maximum of one and a half times. Its ability 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官方开奖结果体彩网:shareholders.

Earnings Variations

• EBITDA: Uses earnin🎐gs 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官方开奖结果体彩网💃:earnings befo🦋re 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官方开奖结果体彩网:capital asset investment or required for emergencies. Analyzing interest coverage ratios over time will often give a cl🧸earer picture 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 potential bond buyers may be comfortable with a lಌess desirable 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 ꦏmonthly debt payments of $30,000. To calculate the interest coverage ratio, convert the monthly interest payments 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官方开奖结果体彩网:liquidity issues and can cover💙 almost 𒊎seven 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官方开奖结果体彩网: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官方开奖结果体彩网: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.