Brief Definition
The interest coverage ratio is a financial metric used to determine how easily a company can pay interest on its outstanding debt. It measures the company’s ability to meet its interest obligations from its earnings before interest and taxes (EBIT).
Further Explanation
The interest coverage ratio is a financial metric used to determine how easily a company can pay interest on its outstanding debt. It measures the company’s ability to meet its interest obligations from its earnings before interest and taxes (EBIT). This ratio is important for creditors and investors as it provides insight into the company’s financial stability and risk of default.
Example:
Suppose a company has an EBIT of $300,000 and its annual interest expense is $50,000. The interest coverage ratio would be: 300,000 / 50,000 = 6
This ratio of 6 indicates that the company earns six times more than what it needs to cover its interest payments. A higher ratio suggests that the company is more capable of meeting its interest obligations, while a lower ratio may indicate potential financial difficulties.