Interest Coverage Ratio

Interest coverage ratio (ICR) measures how comfortably a company’s operating earnings can cover its interest obligations. Higher coverage indicates lower risk of default.

Formula

ICR = EBIT / interest expense

Variant: EBITDA / interest when comparing companies with different depreciation intensity.

Example

EBIT $120k, interest $30k → ICR = 120 / 30 = 4.0× coverage. Using EBITDA $150k: 150 / 30 = 5.0×.

Interpreting Coverage

• ≤1.0×: earnings do not cover interest—high risk.
• 1.5–2.5×: vulnerable in downturns—monitor leverage and cash buffers.
• 3.0–5.0×: generally comfortable coverage for many industries.
• 5.0×+: strong coverage; room for investment or de‑leveraging.

Step‑by‑Step

1. Start with operating income (EBIT) or EBITDA.
2. Find interest expense for the period (income statement).
3. Divide EBIT (or EBITDA) by interest expense to get coverage.
4. Compare to historical periods and peers to assess risk.

Pitfalls

• Using one‑time EBIT spikes; normalize for sustainable operations.
• Ignoring variable interest rates that may rise and reduce coverage.
• Comparing across industries with different capital intensity.

FAQs

EBITDA vs. EBIT?
EBITDA removes non‑cash D&A to compare operating cash potential; EBIT reflects asset intensity.

Thresholds?
Acceptable coverage varies by industry and lender covenants; cyclical sectors target higher buffers.