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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
A company's Interest Coverage Ratio is calculated as EBIT divided by Interest payments.
The interest coverage ratio is a measure of a company's ability to meet its interest payments. A higher ratio indicates a better financial health as it means that the company is more capable to meeting its interest obligations from operating earnings.
A ratio less than 1 would indicate that a company has crippling debt obligations as it uses its entire earnings to pay interest, leaving no income for the common shareholders or to repay back the debt. In such extreme cases, the company would have to sell off its assets, or raise more equity in order to repay some of the debt -- so that it can reduce its interest expense and, in turn, improve the interest coverage ratio.
Example
- Company A generates $200,000 in earnings before interest and taxes in 2007, and has an interest expense of $100,000 during the same period. This would mean that the interest coverage ratio is 2.
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