Interest Coverage Ratio

AAA

DEFINITION of 'Interest Coverage Ratio'

A ratio used to determine how easily a company can pay interest on outstanding debt. The interest coverage ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) of one period by the company's interest expenses of the same period:


Interest Coverage Ratio

INVESTOPEDIA EXPLAINS 'Interest Coverage Ratio'

The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable. An interest coverage ratio below 1 indicates the company is not generating sufficient revenues to satisfy interest expenses.

Things to Remember
  • A ratio under 1 means that the company is having problems generating enough cash flow to pay its interest expenses.
  • Ideally you want the ratio to be over 1.5.

A company that barely manages to cover its interest costs may easily fall into bankruptcy if its earnings suffer for even a single month. To understand more on the importance of this ratio, read Why Interest Coverage Matters To Investors.

VIDEO

RELATED TERMS
  1. Earnings Before Interest & Tax ...

    An indicator of a company's profitability, calculated as revenue ...
  2. Interest Expense

    The cost incurred by an entity for borrowed funds. Interest expense ...
  3. Solvency Ratio

    One of many ratios used to measure a company's ability to meet ...
  4. Debt Ratio

    A financial ratio that measures the extent of a company’s or ...
  5. Debt/Equity Ratio

    A measure of a company's financial leverage calculated by dividing ...
  6. Debt Financing

    When a firm raises money for working capital or capital expenditures ...
Related Articles
  1. Fundamental Analysis

    For which types of investments is the debt service coverage ratio (DSCR) the most useful?

    Understand what the debt service coverage ratio is used for and what types of companies it can best be applied to for equity valuation.
  2. Fundamental Analysis

    What is a bad interest coverage ratio?

    Understand how interest coverage ratio is calculated and what it signifies, and learn what market analysts consider to be an unacceptably low coverage ratio.
  3. Fundamental Analysis

    What is a good interest coverage ratio?

    Learn the importance of the interest coverage ratio, one of the primary debt ratios analysts use to evaluate a company's financial health.
  4. Fundamental Analysis

    What is the difference between interest coverage ratio and DSCR?

    Understand the basics of the interest coverage ratio and the debt-service coverage ratio, including calculations and how each type reflects financial stability.
  5. Investing Basics

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
  6. Investing Basics

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  7. Markets

    A Clear Look At EBITDA

    This measure has its benefits, but it can also present earnings through rose-colored glasses.
  8. Bonds & Fixed Income

    Why Companies Issue Bonds

    When companies need to raise money, issuing bonds is one way to do it. A bond functions like a loan between an investor and a corporation.
  9. Entrepreneurship

    Small Business Financing: Debt Or Equity?

    There are two sources of financing for small businesses: debt and equity financing. This article explains both.
  10. Bonds & Fixed Income

    Why Interest Coverage Matters To Investors

    This ratio represents an important factor of shareholders' returns - find out how to analyze it!

You May Also Like

Hot Definitions
  1. Weather Insurance

    A type of protection against a financial loss that may be incurred because of rain, snow, storms, wind, fog, undesirable ...
  2. Portfolio Turnover

    A measure of how frequently assets within a fund are bought and sold by the managers. Portfolio turnover is calculated by ...
  3. Commercial Paper

    An unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories ...
  4. Federal Funds Rate

    The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution ...
  5. Fixed Asset

    A long-term tangible piece of property that a firm owns and uses in the production of its income and is not expected to be ...
  6. Break-Even Analysis

    An analysis to determine the point at which revenue received equals the costs associated with receiving the revenue. Break-even ...
Trading Center