Interest Coverage Ratio Calculator – Debt Coverage Calculator
Calculate a company's ability to cover interest payments
How to Use
- Enter the company's EBIT (Earnings Before Interest and Taxes)
- Input the total annual interest expense
- Optionally enter revenue for additional analysis
- Calculate to see the interest coverage ratio
- Review the rating and interpretation of financial health
What is the Interest Coverage Ratio?
The interest coverage ratio (ICR), also called the times interest earned ratio, measures how easily a company can pay interest on its outstanding debt. It's calculated by dividing EBIT (Earnings Before Interest and Taxes) by interest expense.
Formula: Interest Coverage Ratio = EBIT / Interest Expense
A ratio of 3.0 means the company earns $3 in EBIT for every $1 of interest expense, indicating it can comfortably cover its interest obligations three times over.
Interpreting the Interest Coverage Ratio
| Ratio | Rating | Interpretation | Investment Risk |
|---|---|---|---|
| ≥5.0 | Excellent | Very strong ability to pay interest; minimal default risk | Low |
| 3.0-4.9 | Good | Comfortable margin; good financial health | Low-Medium |
| 2.0-2.9 | Acceptable | Adequate coverage but limited buffer | Medium |
| 1.5-1.9 | Warning | Marginal coverage; vulnerable to downturns | High |
| <1.5 | Danger | Cannot adequately cover interest; high default risk | Very High |
Lenders typically prefer ratios above 2.5, while ratios below 1.5 indicate the company may struggle to meet interest obligations and could face bankruptcy risk.
Why Interest Coverage Ratio Matters
The interest coverage ratio is crucial for multiple stakeholders:
- Investors: Assess company stability and risk before buying stock or bonds
- Lenders: Determine creditworthiness before extending new loans
- Companies: Monitor debt sustainability and financial health
- Credit rating agencies: Evaluate credit ratings and default probability
- Analysts: Compare companies within the same industry
- Management: Guide decisions about taking on additional debt or paying down existing debt
A declining interest coverage ratio over time signals deteriorating financial health and should prompt investigation.
Limitations and Considerations
- Industry variation: Capital-intensive industries typically have lower ratios than tech companies
- Doesn't account for principal repayment: Only measures interest, not total debt obligations
- Timing: Uses annual figures that may not reflect current conditions
- EBIT volatility: Companies with unstable earnings face higher risk even with good ratios
- Not comprehensive: Should be used alongside other metrics like debt-to-equity ratio
- Excludes lease obligations: May understate total fixed payment obligations
- Cyclical businesses: Ratio can fluctuate significantly with economic cycles
Frequently Asked Questions
- What's a good interest coverage ratio?
- A ratio of 2.5 or higher is generally considered healthy, indicating the company can comfortably cover interest payments. Ratios above 5.0 are excellent. Below 1.5 is concerning and suggests financial distress. However, acceptable ratios vary by industry—compare companies within the same sector.
- Can the interest coverage ratio be negative?
- Yes, if EBIT is negative (the company is operating at a loss), the ratio will be negative. This indicates the company isn't generating enough operating profit to pay interest, let alone cover other obligations. It's a serious red flag for investors and lenders.
- How is this different from the debt service coverage ratio?
- The interest coverage ratio only considers interest payments, while the debt service coverage ratio (DSCR) includes both interest and principal repayments. DSCR provides a more complete picture of debt obligations but requires more detailed financial information.
- Why include revenue as an optional field?
- Revenue helps calculate EBIT margin and interest expense as a percentage of sales. This provides additional context—two companies with the same coverage ratio might have very different profitability profiles. Higher margins generally indicate better financial flexibility.