1. Debt Ratios: Introduction
  2. Debt Ratios: Overview Of Debt
  3. Debt Ratios: The Debt Ratio
  4. Debt Ratios: Debt-Equity Ratio
  5. Debt Ratios: Capitalization Ratio
  6. Debt Ratios: Interest Coverage Ratio
  7. Debt Ratios: Cash Flow To Debt Ratio

The interest coverage ratio is used to determine how easily a company can pay their interest expenses on outstanding debt. The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by the company's interest expenses for the same period. The lower the ratio, the more the company is burdened by debt expense. When a company's interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.

The ratio measures how many times over a company could pay its outstanding debts using its earnings. This can be thought of as a margin of safety for the company’s creditors should the company run into financial difficulty down the road.

The ability to service its debt obligations is a key factor in determining a company’s solvency and is an important statistic for shareholders and prospective investors.

Investors want to be sure that a company they are considering investing in can pay its bills, including its interest expense. They don’t want the company’s growth derailed by these types of financial issues.

Creditors are concerned with the company’s ability to make their interest payments as well. If they are struggling to make the interest payments on their current debt obligations, it doesn’t make any sense for a prospective credit to extend them additional credit.

Trends over time

The interest coverage ratio at a point in time can help tell analysts a bit about the company’s ability to service its debt, but analyzing the interest coverage ratio over time will provide a clearer picture of whether or not their debt is becoming a burden on the company’s financial position. A declining interest coverage ratio is something for investors to be wary of, as it indicates that a company may be unable to pay its debts in the future. However, it is difficult to accurately predict a company’s long-term financial health with any ratio or metric.

Moreover, the desirability of any particular level of this ratio is in the eye of the beholder to an extent. Some banks or potential bond buyers may be comfortable with a less desirable ratio in exchange for charging the company a higher interest rate on their debt.


Debt Ratios: Cash Flow To Debt Ratio
Related Articles
  1. Investing

    Interest Coverage Ratio

    Debt in an important factor to remember when analyzing a company's financial health. The interest coverage ratio serves to determine how easily a company can pay interest on outstanding debt. ...
  2. Investing

    Analyzing AT&T's Debt Ratios in 2016 (T)

    Learn about AT&T Inc. and its key debt ratios, such as the debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio.
  3. Investing

    Analyzing Wal-Mart's Debt Ratios in 2016 (WMT)

    Analyze Wal-Mart's debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio to evaluate the company's financial health and debt management.
  4. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
  5. Investing

    4 Leverage Ratios Used In Evaluating Energy Firms

    These four leverage ratios can help investors understand how oil and gas firms are managing their debt.
  6. Investing

    Analyze Investments Quickly With Ratios

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

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  8. Investing

    Analyzing IBM's Debt Ratios in 2016 (IBM)

    Look over the debt ratios for the IBM Corporation, such as its debt-to-equity ratio, its interest coverage ratio and its cash flow to debt ratio.
  9. Investing

    Analyzing Comcast's Debt Ratios in 2016 (CMCSA)

    Evaluate Comcast's most important debt ratios, and determine whether the company is using debt responsibly and capable of meeting obligations.
Frequently Asked Questions
  1. What's the Best Way to Contact Warren Buffett?

    Learn how to contact Warren Buffett and what kinds of contact is most likely to receive a response from him or from his company, ...
  2. What is the Financial Services Sector?

    A diverse group of companies, beyond banks and credit unions, comprises the financial services sector.
  3. Who are Whole Foods' (WFM) main competitors?

    Whole Foods' main competitors are Sprouts Farmers Markets and Trader Joe's. However, the recent acquisition by Amazon my ...
  4. What caused the Stock Market Crash of 1929 that preceded the Great Depression?

    Find out what led to the stock market crash of 1929, which in turn led to the Great Depression. It sparked a nearly 90% loss ...
Trading Center