EBITDA-to-Interest Coverage Ratio
Candlefocus EditorEBITDA coverage is more inclusive than the standard Interest Coverage Ratio (ICR) because it additionally takes into account depreciation and amortization. This is important because depreciation and amortization are non-cash expenses that can reduce a company’s reported earnings. By considering EBITDA, which already excludes these expenses, EBITDA coverage is more reflective of a company’s actual capacity to generate the cashflow required to pay interest payments.
Lenders, in particular, are interested in a company’s EBITDA coverage ratio to get a sense of how likely it is that a company can handle any future expenses such as debt service charges. For instance, if a company has an EBITDA coverage ratio of 2.0, this indicates that it produces twice as much earnings as it spends on interest payments. On the other hand, if a company’s coverage ratio is below 1.0, it is at risk of defaulting on interest payments.
A higher EBITDA coverage ratio indicates that a company’s cash flow is sufficient to pay its principal and interest payments, leaving excess earnings for reinvestment rather than solely being used to service existing debts. The ideal EBITDA coverage ratio varies by industry and depends on the purpose of the debt - whether it is used for operating or investment purposes. Generally speaking, higher ratios are preferable as they show a company has a greater capacity to handle large debt loads.
In summary, the EBITDA-to-Interest Coverage Ratio is an important financial ratio used to measure a company’s ability to pay interest payments on its debt. EBITDA coverage is a more comprehensive measure of a company’s capacity to generate enough cashflow to service its debt since it additionally takes into account non-cash expenses such as depreciation and amortization. A higher EBITDA coverage ratio indicates that a company is more likely to have sufficient cashflow to meet its liabilities and has more funds for reinvestment and other business activities.