It is the ratio between the EBIT and the total interest paid by the company. The ratio shows the total interest expense of the company that is subtracted from its total earnings before interest and taxes. It is a financial tool that helps in finding the financial stability of a company. It is considered to be the leverage ratio that helps in determining the feasibility of a company against its debt collections. Formula of Interest Coverage Ratio can be shown as under:-
Interest Coverage Ratio = EBIT (Earnings before Interest and Taxes)/ Total Interest Expense
The higher is the ratio the higher is the company stability and higher is its chances of meetings its financial obligations. The trends or ups and downs of this ratio can be used to predict the financial position of a company over a certain period of time. The degree or the value of interest coverage ratio also varies from one industry to the other. For example a gas producer may have an interest coverage ratio of 5 where as a utility provider may have an interest coverage ratio of 4.
Interest coverage ratio also provides valuable information to its investors as the investor can find the trend of the company regarding the value of its assets, total revenue generated by the company, total expenses of the company and ability of the company to meet financial obligations in future. One important thing while calculating interest coverage ratio that must be kept in mind is that the earnings of a business can fluctuate more as compared to the interest expense of that business.
Other Related Accounting Articles: