As the name indicates interest coverage ratio is the ratio that depicts the ability of a company to cover its interest expense. This is the ratio that shows whether a company has an ability of paying interest that is accumulated over the outstanding debt of the company. The high value of the interest coverage ratio indicates that a company has the ability to pay its interest expense that is collected over its loans. On the other hand the low value of interest coverage ratio shows that company is unable to fulfill its interest expense and may default on the debt payments.
The interest coverage ratio can be calculated by diving total earnings of the company before paying taxes and interests to the total interest expense of that company. The formula of interest coverage ratio can be shown as follows:-
Interest Coverage Ratio = Earnings before interest and taxes/ Total Interest Expense
For example a company has earnings of $5,000,000 before paying the interest expense and taxes associated with the company. The total interest expense as compared to the earnings for that month is $2,500,000. With the help of these two figures we can find out the interest coverage ratio that is
Interest coverage ratio = 5,000,000/ 2,500,000
Interest Coverage Ratio = 2:1
This shows that earnings of the company is double as compared to the interest expense of the company as a result earnings are sufficient to pay the interest expense of the company.
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