What Is the Interest Coverage Ratio (ICR)?

The interest coverage ratio (ICR) is a financial ratio that measures a company's ability to handle its outstanding debt.

The ratio is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense. A low ICR indicates that the company's debt is great and, therefore, so is the possibility of bankruptcy. A higher ICR indicates stronger financial health.

Calculating the Interest Coverage Ratio (ICR)

The interest coverage ratio is calculated by dividing earnings before interest and taxes (EBIT) by the total interest expenses on the company's outstanding debts. A company's debt can inܫclude lines of credit, loans, and bonds.

For example, if a company's earnings before taxes and interest amount to $50,000 and its total interest payment requirements equal $25,000, then its interest coverage ratio is 2.0 ($50,000/$25,000 = 2).

Interpreting the Interest Coverage Ratio (ICR)

If a company has a low ICR, it is more likely to fail to service its debt, putting it at a greater risk of 澳洲幸运5官方开奖结果体彩网:bankruptcy. A low ICR means there is less profit available to meet the debt's👍 interest expense. Also, if the company has variable-rate debt, the interest expense will rise in a rising interest-rate environment. 

澳洲幸运5官方开奖结果体彩网:A high ratio indicates there are enough profits available to service the debt. But, it may also mean the com𒆙pany is not using its debt properly. For example, if a company is not borrowing enough, it may not be investing in new products and technologies to stay ahead of the competition in the long term.

Optimal Interest Coverage Ratio (ICR)

What constitutes good interest coverage varies not only between industries but also between companies in the same industry. Here are some gener♏al thoughts about the ratio:

• Some consider an interest coverage ratio of at least 2.0 to be the minimum acceptable amount for a company with solid, consistent revenues.
• Depending on the industry, some analysts prefer a coverage ratio of three (or higher).
• A coverage ratio below one indicates a need for further investigation to determine a company's financial health.

The Importance of the Interest Coverage Ratio

The interest coverage ratio is an important figure for creditors who want to determine whe🌼ther a company can pay back its debt. If it has trouble doing so,ꦅ future creditors are less likely to extend it credit.

Similarly, both shareholders and investors can also use this ratio to make decisions about their investments. A company that can't pay back its interest expenses is in danger of growing its existing debts. This can keep it from accessing more debt if it needs it for expansions, research and development, or other growth-related investments; it also can keep it from paying down existing debt principles.

Types of Interest Coverage Ratios

There are a few types of interest coverage ratios. Each serves a diff൩erent purpos♔e:

• EBITDA Interest Coverage Ratio: Indicates how many times a company can pay upcoming interest expenses by dividing its earnings before interest, taxes, depreciation, and amortization (EBITDA) by its interest expenses.
• EBITDA Less CapEx: Indicates how many times a company's EBITDA can pay its upcoming interest expenses after 澳洲幸运5官方开奖结果体彩网:capital expenditures (CapEx) are deducted. The formula for this type of coverage ratio is (EBITDA – CapEx) ÷ (Interest Expense).
• Fixed Charge Coverage Ratio: This metric helps determine a company's ability to service its fixed expenses, such as rent or utilities. The formula can be ( EBIT + Fixed Charges ) ÷ (Fixed Charges Before Taxes + Interest ), but there are several variations depending on the business.
  

Limitations of the Interest Coverage Ratio

A higher interest coverage ratio is usually desirable because it means a company can better fulfill its financial obligations. But, this isn't always a hard-and-fast rule because this metric can be fluid.

Higher ratios are better for companies and industries that are susceptible to volatility. However, lower coverage ratios are often suitable for companies that fall in specific industries, including those that are heavily regulated. So, it's important to refrain from comparing companies that aren't in the same industry. For instance, it's not useful to compare a utility company (which normally has a low coverage ratio) with a retail store.

The Bottom Line

Many metrics can help you determine companies' financial health and well-being and, therefore, your investment portfolio. One of those metrics is the interest coverage ratio. This figure measures a company's ability to cover its interest obligations. Knowing how to calculate it—and using it alongside other financial metrics—can help you become a well-informed investor and make better decisions about your investments.