How To Calculate Coverage Ratio

Coverage Ratio Formula:

\[ \text{Coverage Ratio} = \frac{\text{EBIT}}{\text{Interest Expense}} \]

Coverage Ratio:

Unit Converter ▲

Unit Converter ▼

From:	To:

1. What is the Coverage Ratio?

The Coverage Ratio, also known as Interest Coverage Ratio, measures a company's ability to pay interest expenses on outstanding debt from its earnings before interest and taxes (EBIT). It indicates the financial health and debt servicing capacity of a business.

2. How Does the Calculator Work?

The calculator uses the Coverage Ratio formula:

\[ \text{Coverage Ratio} = \frac{\text{EBIT}}{\text{Interest Expense}} \]

Where:

\( \text{EBIT} \) — Earnings Before Interest and Taxes (USD)
\( \text{Interest Expense} \) — Total interest payments on debt (USD)

Explanation: The ratio shows how many times a company can cover its interest payments with its operating earnings. Higher ratios indicate better financial stability.

3. Importance of Coverage Ratio Calculation

Details: The Coverage Ratio is crucial for lenders, investors, and analysts to assess a company's debt servicing capability, financial risk, and creditworthiness. It helps in evaluating the company's ability to meet its interest obligations during economic downturns.

4. Using the Calculator

Tips: Enter EBIT and Interest Expense in USD. Both values must be positive, with Interest Expense greater than zero for valid calculation.

5. Frequently Asked Questions (FAQ)

Q1: What is considered a good Coverage Ratio?
A: Generally, a ratio above 1.5 is considered acceptable, while ratios above 2.0-3.0 are considered good. Ratios below 1.0 indicate the company cannot cover its interest expenses from operating earnings.

Q2: How does Coverage Ratio differ from Debt Service Coverage Ratio?
A: Coverage Ratio focuses only on interest payments, while Debt Service Coverage Ratio includes both interest and principal repayments in the denominator.

Q3: What are the limitations of Coverage Ratio?
A: It doesn't consider principal repayments, seasonal fluctuations, or non-operating income. It should be used alongside other financial metrics for comprehensive analysis.

Q4: How often should Coverage Ratio be calculated?
A: It should be calculated quarterly and annually as part of regular financial analysis, and more frequently during periods of financial stress or when considering new debt.

Q5: Can Coverage Ratio be negative?
A: Yes, if EBIT is negative (company is operating at a loss), the ratio will be negative, indicating severe financial distress and inability to cover interest payments.