Interest Coverage Ratio Calculator

The Interest Coverage Ratio is used to assess whether a company can pay the interest on its debt with its operating profit. By dividing EBIT (earnings before interest and taxes) by the interest paid, you get a figure that indicates how many times the current earnings cover the amount of interest payments. A value of 5 means that the company makes an operating profit that is five times the amount of interest incurred. A value of 0.8 indicates that the profits made are not enough to cover the interest payments incurred. Credit institutions, bond analysts and finance directors pay close attention to this indicator, especially when a company increases its debt or goes through difficult times. This calculation tool can calculate the indicator both from EBIT and paid interest, as well as vice versa. If one of the two values is entered, the other value can be determined.

What the interest coverage ratio measures:

This factor indicates how many times operating income covers current interest payments. EBIT is used in the numerator because it represents clear core business profit and excludes effects of financing and tax decisions. The denominator, interest paid, includes all interest due during the period in question. This includes interest on corporate bonds, loans, revolving credit facilities, and leases. Only the interest portion is considered; principal repayments are not included.

This indicator is often also referred to as Times Interest Earned (TIE). The calculation method is identical; only the name differs. In contrast to leverage ratios, here it applies that the higher the value, the better. The more times interest payments can be covered, the greater the buffer against falls in profits or rising interest rates.

How to calculate this indicator in the income statement:

Only two values are needed, both of which come from the income statement for the same period.

1. EBIT (sometimes referred to as operating profit) is above interest expense. If not directly stated, it can be calculated by taking revenues minus cost of goods sold and then subtracting operating expenses.

2. Interest expense is usually directly below the EBIT. It includes all interest that results from debt but not repayment of principal.

3. Divide your EBIT by your interest expense. The result is your interest coverage ratio.

Make sure that the time frames are consistent. If you compare quarterly EBIT with annual interest expenses, this can lead to a distorted figure because of seasonal fluctuations. It is safer to use data from the last twelve months as it will balance out any seasonal effects.

Calculation possible both ways:

This formula represents a simple relationship between three values, so if you know any two of them you can calculate the third. Leave blank the field for the value that you want to calculate and enter the other two values.

This tool is useful not only for textbook exercises but also for planning. If a loan covenant requires a minimum interest coverage ratio and you know the amount of your interest payments, this tool will calculate the required EBIT to meet that threshold. Alternatively, you can set the interest coverage ratio and EBIT to determine the maximum allowable interest expense before taking on new debt.

Example of a full calculation.

Say a company reports an annual EBIT of $480,000 and has interest expenses of $120,000.

Thus, the operating profit can cover four times the interest payments. In other words, for every dollar of EBIT, 25 cents is "eaten up" by interest, leaving 75 cents as earnings before taxes. The following table shows the values in this example and explains each term.

How high must the interest coverage ratio be to be considered good?

There are no uniform targets but many analysts generally use the following rough guidelines: below 1.0 the company can barely cover interest with operating profit which is a difficult situation, between 1.0 and 1.5 the company can just about cover interest and even small setbacks may have an impact, between 1.5 and 2.5 coverage is acceptable but there's very little room for manoeuvre, between 2.5 and 5.0 it's a healthy position which many lenders will want to see before granting new credit, above 5.0 the coverage is very strong. However, a very high multiple can also mean that the company has too little debt financing and isn't taking advantage of low-cost tax-deductible debt.

Industry comparison values

What is considered healthy depends almost entirely on the industry. Capital-intensive companies with stable cash flows can safely operate even at relatively low multiples, while companies with highly volatile earnings need more room to play. The most reliable yardstick is not fixed thresholds but always direct comparability with other companies in the same industry. In addition, trends over several quarters are more important than data points at a particular point in time.

EBIT, EBITDA and EBITDA less capital expenditure ratio multiples.

Analysts generally calculate this multiple in three ways. The EBIT version mentioned above is a common compromise. The EBITDA version adds back depreciation and amortization to the numerator, which leads to higher multiples and more positive results. This is useful for analyzing capital-intensive companies whose reported profits are burdened by large non-cash charges. The most conservative version accounts for capital expenditures, since companies that require continuous reinvestment in order to maintain operations actually have less cash available to pay interest.

If you open the range for the variants of the ratio multiplier in the calculator tool, you can compare the three results side by side. In this case, the highest is the EBITDA ratio, the lowest is the EBITDA minus capital expenditure ratio and EBIT is somewhere in between.

Comparison of interest coverage ratio, times interest earned and debt service coverage ratio.

All three related ratios measure the ability to repay but differ in what positions are considered. The interest coverage ratio and times interest earned provide the same result, EBIT divided by interest expense, and thus are just alternative names for the same value. The debt service coverage requirement is more stringent as it divides operating income by total debt service payments. Total debt service includes both scheduled principal repayments and interest payments. If a company actively repays capital, then the interest coverage ratio can be acceptable while the debt service coverage ratio will be worse. For this reason lenders in project finance and real estate finance prefer the version for debt service coverage.

How to improve a low multiplier.

Even if the interest coverage ratio is low there are ways to improve it. Measures that aim at increasing the EBIT faster than the interests or lowering the interest expenses can all help in improving the ratios. Common methods include: raising prices or reducing cost positions to increase operating profit, refinancing high-interest debts when the interest coverage ratio exceeds a certain value (2.5) and banks compete for the opportunity of this business, extending short-term debt into longer maturity to reduce annual interest burden, paying down capital with excess liquid funds, and fixing interest rates to avoid sudden rise in interest rate overburdening liquidity. The target planning function in this calculation tool shows exactly how much EBIT needs to be raised or interests reduced to achieve the desired interest coverage ratio.