Interest coverage ratio
The interest coverage ratio divides operating profit (EBIT) by interest expense to measure how comfortably a company's trading earnings cover its debt servicing costs; a ratio below 2 is commonly treated as a warning signal.
FrameworkRatio analysis
See it move
A company with EBIT of €800,000 and annual interest expense of €200,000 has an interest coverage ratio of 4×, meaning operating profit could pay the interest bill four times over. Ratios above 3 are comfortable; a ratio near 1 signals a trading downturn could jeopardise debt service.
The formula
Variables
- Earnings before interest and tax (operating profit) (€)
- Finance cost recognised in the income statement for the period (€)
A ratio above 3 is generally considered comfortable; a ratio approaching 1 signals that a trading downturn could jeopardise debt service. Loan covenants frequently specify a minimum level.
Check yourself
Dorado plc reports: revenue €4,000,000; cost of sales €2,400,000; operating expenses €800,000; interest expense €240,000; tax charge €112,000. What is Dorado's interest coverage ratio?