Interest Coverage Ratio (ICR)

Interest Coverage Ratio (ICR) is a financial metric used to determine a company’s ability to pay interest on its outstanding debt. It is calculated by dividing the company’s earnings before interest and taxes (EBIT) by its interest expenses. A higher ratio indicates that the company can easily meet its interest obligations, while a lower ratio may signal potential financial distress.

Formula:

ICR = EBIT / Interest Expenses

Example 1:

If a company has an EBIT of $500,000 and interest expenses of $100,000, the ICR would be:

ICR = $500,000 / $100,000 = 5

This means the company earns five times its interest obligations.

Example 2:

If another company has an EBIT of $200,000 and interest expenses of $150,000, the ICR would be:

ICR = $200,000 / $150,000 = 1.33

This indicates the company earns only 1.33 times its interest obligations, suggesting potential difficulties in covering interest payments.

Case Consideration:

In general, a ratio above 2 is considered healthy, as it indicates sufficient earnings to cover interest expenses comfortably. Ratios below 1 can indicate that a company is not generating enough income to cover its interest expenses, which may lead to financial trouble or default.