Interest Coverage Ratio
Candlefocus EditorThe Interest Coverage Ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense during a given period. This calculation provides insight into how well a company’s earnings support the burden of its interest expenses. The formula can also be modified to use EBITDA or EBIAT instead of EBIT.
An ideal Interest Coverage Ratio can differ one industry to the next. A higher ratio is generally associated with better repayment capacity, and an acceptable ratio will depend on each company’s specific circumstances. That is to say, a company with higher debt levels may require a higher interest coverage ratio in order to be deemed financially healthy.
In conclusion, the Interest Coverage Ratio is an incredibly useful measure of a company’s short-term solvency. It is calculated by dividing a company’s EBIT, EBITDA or EBIAT by its interest expense. Generally, a higher ratio is better for a firm’s financial health - however the ideal ratio can vary by industry. The Interest Coverage Ratio allows investors, lenders and creditors to make a judgment on a company’s ability to pay their outstanding debt.