Interest coverage ratio is used for the determination of company’s capability to repay the interest on outstanding debt. It is also known as profitability ratio and debt ratio. This ratio can be calculated by dividing the earnings before interest and tax of a company with the amount of interest to be paid by the company during the same period.
Explanation of Interest Coverage Ratio
Interest coverage ratio measures that how many times a company can pay its interest expense with the available earnings. In other words, it is a safety margin of a company to repay its interest expense and it is the most important factor in the return to shareholders. The lower interest coverage ratio of a company shows that it is burdened with debt expenses.
The ability of a company to pay its interest expense is questionable if this ratio is 1.5 or lower. The value of the ratio as 1.5 is the minimum acceptable value of a company, reflects that lenders will likely refuse to lend more money to the company. Furthermore, it the ratio is below the value of 1, it shows that company is not generating sufficient revenue to meet its interest expense.