Interest Coverage Ratio Calculator
This tool calculates the Interest Coverage Ratio (ICR), a fundamental financial metric used to assess a company's ability to pay interest on its debt.
Enter the company's **Earnings Before Interest and Taxes (EBIT)** and its **Interest Expense**. The calculator will provide the resulting ratio.
Enter Financial Data
Understanding the Interest Coverage Ratio
What is the Interest Coverage Ratio (ICR)?
The Interest Coverage Ratio is a solvency and debt ratio used to determine how easily a company can pay interest expenses on its outstanding debt. It is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expenses during a given period.
ICR Formula
The formula is simple and direct:
ICR = EBIT / Interest Expense
Interpreting the Ratio
- Higher Ratio: A higher ratio indicates that a company has more earnings available to cover its interest obligations. This is generally seen as a positive sign by lenders and investors, suggesting lower risk of default on interest payments.
- Lower Ratio: A lower ratio suggests that a company has less financial cushion to meet its interest payments. Ratios below 1.5 or 2 times are often considered risky, although the acceptable ratio varies significantly by industry.
- Ratio of 1 or Less: A ratio of 1 means the company's EBIT is exactly equal to its interest expense. Any decline in earnings would make it difficult or impossible to pay interest. A ratio below 1 means the company is not generating enough earnings to cover its interest payments, which is a serious financial distress signal.
- Negative EBIT: If EBIT is negative (a loss), the ratio will be negative. This immediately indicates the company cannot cover its interest expense from operating earnings.
- Zero Interest Expense: If a company has no debt and thus no interest expense, the denominator is zero. The ratio is technically undefined or considered infinite, indicating very strong coverage (no interest burden). The calculator handles this case separately.
Analysts and lenders often look at trends in the ICR over time and compare it to industry benchmarks.
Interest Coverage Ratio Examples
Click on an example to see the calculation details:
Example 1: Healthy Company
Scenario: A stable company with good profitability.
Known Values: EBIT = $500,000, Interest Expense = $50,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $500,000 / $50,000 = 10
Result: ICR = 10 times.
Conclusion: The company's earnings are 10 times its interest expense, indicating strong ability to service its debt interest.
Example 2: Moderate Risk
Scenario: A company with moderate debt or slightly lower earnings.
Known Values: EBIT = $150,000, Interest Expense = $75,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $150,000 / $75,000 = 2
Result: ICR = 2 times.
Conclusion: The company's earnings are 2 times its interest expense. This is acceptable in some industries but might be considered low in others, indicating less cushion.
Example 3: High Risk / Low Coverage
Scenario: A company struggling with earnings or high debt.
Known Values: EBIT = $80,000, Interest Expense = $100,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $80,000 / $100,000 = 0.8
Result: ICR = 0.8 times.
Conclusion: The ICR is below 1. The company's earnings are not sufficient to cover its interest expense, a clear sign of financial difficulty.
Example 4: Operating Loss
Scenario: A company experiencing an operating loss.
Known Values: EBIT = -$20,000, Interest Expense = $10,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = -$20,000 / $10,000 = -2
Result: ICR = -2 times.
Conclusion: A negative ICR means EBIT is negative. The company is losing money from operations and cannot cover its interest payments.
Example 5: Zero Interest Expense
Scenario: A company with no debt financing.
Known Values: EBIT = $1,000,000, Interest Expense = $0.
Formula: ICR = EBIT / Interest Expense
Calculation: Division by zero.
Result: ICR is Undefined / Infinite.
Conclusion: The company has no interest burden, indicating extremely strong coverage (or rather, no debt to cover). The tool will indicate this case.
Example 6: Small, Profitable Business
Scenario: A small business with minimal debt.
Known Values: EBIT = $80,000, Interest Expense = $2,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $80,000 / $2,000 = 40
Result: ICR = 40 times.
Conclusion: Very high ICR, showing excellent ability to handle its small interest obligations.
Example 7: Capital-Intensive Industry
Scenario: A company in an industry where higher debt levels are common.
Known Values: EBIT = $5,000,000, Interest Expense = $2,000,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $5,000,000 / $2,000,000 = 2.5
Result: ICR = 2.5 times.
Conclusion: While lower than Example 1, this might be considered adequate within its specific industry context.
Example 8: High Growth, High Debt Startup
Scenario: A rapidly expanding company using significant debt financing.
Known Values: EBIT = $1,200,000, Interest Expense = $800,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $1,200,000 / $800,000 = 1.5
Result: ICR = 1.5 times.
Conclusion: This is a low ratio, indicating vulnerability if earnings growth slows. Lenders would monitor this closely.
Example 9: Seasonal Business Dip
Scenario: A business in its off-season with lower earnings.
Known Values: EBIT = $10,000, Interest Expense = $15,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $10,000 / $15,000 ≈ 0.67
Result: ICR ≈ 0.67 times.
Conclusion: During this period, earnings don't cover interest. This highlights the importance of looking at ICR over a full year or business cycle for seasonal companies.
Example 10: Acquisition with High Debt
Scenario: A company recently took on significant debt for an acquisition.
Known Values: EBIT = $2,500,000, Interest Expense = $2,400,000.
Formula: ICR = EBIT / Interest Expense
Calculation: ICR = $2,500,000 / $2,400,000 ≈ 1.04
Result: ICR ≈ 1.04 times.
Conclusion: This extremely tight ratio shows very little room for error in meeting interest payments, a common scenario after highly leveraged transactions.
Frequently Asked Questions about Interest Coverage Ratio
1. What does the Interest Coverage Ratio measure?
It measures a company's ability to pay the interest expenses on its outstanding debt using its operating earnings (EBIT).
2. What is considered a good Interest Coverage Ratio?
A ratio above 1.5 or 2 is generally preferred, but what's "good" is highly dependent on the industry, the company's size, and economic conditions. Highly stable industries might have lower acceptable ratios than volatile ones.
3. Why is EBIT used instead of Net Income?
EBIT (Earnings Before Interest and Taxes) is used because interest payments are paid before taxes and are a cost of financing, not operations. Using EBIT shows the earnings generated from core business operations that are available to cover interest.
4. What happens if Interest Expense is zero?
If a company has no interest expense (zero debt), the ratio is technically undefined by division but signifies that there are no interest payments to cover. It indicates extremely strong "coverage" in the sense of no debt burden.
5. Can the Interest Coverage Ratio be negative?
Yes, if the company has an operating loss (EBIT is negative), the ratio will be negative. This means the company's core operations are not generating enough revenue to cover even their operating costs, let alone interest expenses.
6. What are the limitations of the ICR?
It's a snapshot; it doesn't account for principal debt payments, capital expenditures, or changes in working capital. It also varies greatly by industry, making cross-industry comparisons difficult without context.
7. Is a higher or lower ICR better?
Generally, a higher ICR is better, as it indicates a greater ability to meet interest obligations and less financial risk. However, an extremely high ratio might suggest the company is not using debt effectively to leverage its growth.
8. How does the ICR relate to bankruptcy risk?
A persistently low or negative ICR is a significant indicator of potential financial distress and increased risk of defaulting on debt obligations, which can lead to bankruptcy.
9. Do all companies have an Interest Coverage Ratio?
Companies that do not have any interest-bearing debt will have an interest expense of zero, making the standard calculation undefined. They have no interest coverage concern.
10. Where can I find EBIT and Interest Expense for a public company?
These figures are typically found on a company's income statement (also known as the Profit and Loss statement) in their financial reports.
