A coverage ratio is a metric that measures a companyâ€™s ability to pay its financial obligations. Generally, the higher the coverage ratio, the better able the business is to meet its debt obligations.
Itâ€™s best to compare coverage ratios of companies in the same industry or sector of the economy.Â Coverage ratio comparisons across industries are not useful, as companies in different industries use debt in different ways.
The three most common coverage ratios are: interest coverage ratio, debt coverage ratio and asset coverage ratio.
The interest coverage ratio is calculated by dividing earnings before interest and taxes (EBIT) by the interest expenses from the same accounting period. Generally, a ratio of 1.5 or better is preferred.Â This means that the company earns one and a half times what it needs to pay its interest obligations.
The debt coverage ratio is calculated by dividing net income by the sum of total principal and interest payments.Â A ratio below 1 means the company is not earning enough to pay off debt principal balances owed to its creditors.Â
The forwardlooking asset coverage ratio focuses on a companyâ€™s longterm prospects of paying its debts. The more assets a company has in relation to its debt, the better its chances are of paying off its debts. The asset coverage ratio formula is:
[(Total Assets â€“ Intangible Assets) â€“ (Current Liabilities â€“ Short term obligations)]/Total Debt
There is no standard for an asset coverage ratio as it varies depending on the industry.
In This Series

Investing
An Introduction To Coverage Ratios
Interest coverage ratios help determine a company's ability to pay down its debt. 
Investing
Analyzing WalMart's Debt Ratios in 2016 (WMT)
Analyze WalMart's debttoequity ratio, interest coverage ratio and cash flowtodebt ratio to evaluate the company's financial health and debt management. 
Investing
Analyzing General Electric's Debt Ratios in 2016 (GE)
Evaluate GE's debt picture using the most important metrics for a largecap conglomerate, including the debttoequity (D/E) ratio and the interest coverage ratio. 
Investing
Analyzing AT&T's Debt Ratios in 2016 (T)
Learn about AT&T Inc. and its key debt ratios, such as the debttoequity ratio, interest coverage ratio and cash flowtodebt ratio. 
Investing
Debt Ratios
Learn about the debt ratio, debtequity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio. 
Investing
Understanding Leverage Ratios
Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios  including the debt, ... 
Investing
4 Leverage Ratios Used In Evaluating Energy Firms
Analysts use specific leverage ratios to compare firms within an industry. A basic understanding of these ratios helps when evaluating oil and gas stocks. 
Investing
Analyze Investments Quickly With Ratios
Make informed decisions about your investments with these easy equations. 
Insurance
Explaining the Liquidity Coverage Ratio
The liquidity coverage ratio requires banks and other financial institutions to hold enough cash and liquid assets on hand to weather market stress.