{"id":8729,"date":"2023-08-23T15:18:49","date_gmt":"2023-08-23T09:48:49","guid":{"rendered":"https:\/\/razorpay.com\/learn\/?p=8729"},"modified":"2024-03-11T14:35:48","modified_gmt":"2024-03-11T09:05:48","slug":"interest-coverage-ratio-a-guide","status":"publish","type":"post","link":"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/","title":{"rendered":"How to Calculate Interest Coverage Ratio (And Why It Matters)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_80 counter-hierarchy ez-toc-counter ez-toc-transparent ez-toc-container-direction\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<label for=\"ez-toc-cssicon-toggle-item-69d8fe3c3b42a\" class=\"ez-toc-cssicon-toggle-label\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/label><input type=\"checkbox\"  id=\"ez-toc-cssicon-toggle-item-69d8fe3c3b42a\"  aria-label=\"Toggle\" \/><nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#What-is-Interest-Coverage-Ratio\" >What is Interest Coverage Ratio?\u00a0<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#Importance-of-ICR-in-Business\" >Importance of ICR in Business<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#Interest-Coverage-Ratio-Formula\" >Interest Coverage Ratio Formula\u00a0<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#Interpreting-Interest-Coverage-Ratio\" >Interpreting Interest Coverage Ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#Types-of-Interest-Coverage-Ratios\" >Types of Interest Coverage Ratios<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#Limitations-of-Interest-Coverage-Ratio\" >Limitations of Interest Coverage Ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/razorpay.com\/learn\/business-banking\/interest-coverage-ratio-a-guide\/#FAQs\" >FAQs<\/a><\/li><\/ul><\/nav><\/div>\n<h2><span class=\"ez-toc-section\" id=\"What-is-Interest-Coverage-Ratio\"><\/span><b>What is Interest Coverage Ratio?\u00a0<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p data-sourcepos=\"5:1-5:229\">The interest coverage ratio (ICR) is a financial metric that measures a company&#8217;s ability to pay its interest expenses. It is calculated by dividing the company&#8217;s earnings before interest and taxes (EBIT) by its interest expense.<\/p>\n<p data-sourcepos=\"7:1-7:190\">A high ICR indicates that a company has a healthy financial position and is able to easily meet its interest obligations. A low ICR, on the other hand, may be a sign of financial difficulty.<\/p>\n<p><span style=\"font-weight: 400;\">Financial analysts and investors use the interest coverage ratio to understand a company\u2019s ability to pay off the accumulated interest on debt. It is a powerful indicator of a company&#8217;s financial health and current debt burden.<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Importance-of-ICR-in-Business\"><\/span>Importance of ICR in Business<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Why do businesses and lenders calculate the interest coverage ratio?<\/p>\n<p><strong>Creditworthiness:\u00a0<\/strong><span style=\"font-weight: 400;\">Companies borrow money from various financial institutions and other sources. <\/span><span style=\"font-weight: 400;\">These lenders need assurance that they\u2019ll receive their payments with interest regularly. The ICR helps lenders understand whether the business will be able to make interest payments or not.<\/span><\/p>\n<p><strong>Financial health: <\/strong><span style=\"font-weight: 400;\">Interest coverage ratio can be assessed to check the short-term financial health of a company.\u00a0<\/span>A consistently dropping ICR means that the business&#8217;s earnings are falling while its debt is increasing.<\/p>\n<p><strong>Business trends: <\/strong>I<span style=\"font-weight: 400;\">nterest coverage ratio of previous years can be used for trend analysis to determine a company\u2019s ability to repay interest.\u00a0<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Interest-Coverage-Ratio-Formula\"><\/span><b>Interest Coverage Ratio Formula\u00a0<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">The formula for calculating ICR is as follows:\u00a0<\/span><\/p>\n<p><code><span style=\"font-weight: 400;\">Interest coverage ratio = Earnings before interest and taxes \/ interest expense<\/span><\/code><\/p>\n<ul>\n<li><span style=\"font-weight: 400;\">EBIT = Business&#8217;s operating profit\u00a0<\/span><\/li>\n<li><span style=\"font-weight: 400;\">Interest Expense = Total interest payable on all borrowings\u00a0<\/span><\/li>\n<\/ul>\n<h2><span class=\"ez-toc-section\" id=\"Interpreting-Interest-Coverage-Ratio\"><\/span>Interpreting Interest Coverage Ratio<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<table>\n<tbody>\n<tr>\n<th>Interest Coverage Ratio (ICR)<\/th>\n<th>Interpretation<\/th>\n<\/tr>\n<tr>\n<td>1 or less<\/td>\n<td>The company is struggling to meet its interest obligations and may be at risk of defaulting on its loans.<\/td>\n<\/tr>\n<tr>\n<td>1.5 to 2<\/td>\n<td>The company is in a healthy financial position and has sufficient funds to meet its interest obligations.<\/td>\n<\/tr>\n<tr>\n<td>2 or more<\/td>\n<td>The company is in a very strong financial position and has more than enough funds to meet its interest obligations.<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<p>&nbsp;<\/p>\n<p><span style=\"font-weight: 400;\">Now, let&#8217;s check how the interest coverage ratio is interpreted by financial analysts and investors:\u00a0<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>High Interest Coverage Ratio\u00a0<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">A high ICR value indicates that a company is financially strong and has sufficient funds to pay its interest obligations. An ICR of 1 indicates that the company needs to use its entire earnings to pay its interest on time. For a company to have sufficient earnings for interest payments, it needs to have an ICR of 1.5 or more.<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>Low-Interest Coverage Ratio\u00a0<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">A low-interest coverage ratio indicates that a company may not be able to able to manage its debts effectively. In other words, the company will need to use liquidate its assets to repay its loans.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">Remember that if you come across an organisation that consistently exhibits a low-interest coverage ratio, it indicates the organisation is incapable of repayment.<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Types-of-Interest-Coverage-Ratios\"><\/span><b>Types of Interest Coverage Ratios<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">There are several ways to calculate the ICR of a company. Besides using EBIT, you can use other metrics like EBITDA, EBIAT, fixed charge and EBITDA minus capex.<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>EBITDA Interest Coverage Ratio\u00a0<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">EBITDA (earnings before interest, tax, depreciation and amortisation) coverage ratio helps determine how many times EBITDA can service the interest expense which is due.\u00a0<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>EBITDA Less Capex Interest Coverage Ratio\u00a0<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">You can use this interest coverage ratio to check the number of times EBITDA can be used to service the interest expense after the deduction of capex.\u00a0<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>EBIAT Interest Coverage Ratio<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">Instead of using EBIT, you use earnings before interest after taxes. As companies must pay taxes, it provides a more realistic picture of a company\u2019s capacity to pay interest on loans.<\/span><\/p>\n<ul>\n<li aria-level=\"1\"><b>Fixed Charge Coverage Ratio (FCCR)\u00a0<\/b><\/li>\n<\/ul>\n<p><span style=\"font-weight: 400;\">FCCR measures the ability of a company to pay all of its short-term financial requirements. It can be adjusted to include rent expenses as well.\u00a0<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Limitations-of-Interest-Coverage-Ratio\"><\/span>Limitations of Interest Coverage Ratio<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>While the ICR is a robust metric to determine creditworthiness and short-term financial health, there are a few limitations that must be kept in mind.<\/p>\n<ul data-sourcepos=\"5:1-9:0\">\n<li data-sourcepos=\"5:1-5:205\"><strong>It only considers a company&#8217;s current interest expenses.<\/strong>\u00a0The ICR does not take into account future interest expenses, which could increase if the company takes on more debt or if interest rates rise.<\/li>\n<li data-sourcepos=\"6:1-6:315\"><strong>It does not consider a company&#8217;s cash flow.<\/strong>\u00a0The ICR only considers a company&#8217;s earnings before interest and taxes (EBIT), which is not always a good indicator of a company&#8217;s cash flow. A company with a high ICR could still have difficulty meeting its interest obligations if it does not have enough cash flow.<\/li>\n<li data-sourcepos=\"7:1-7:243\"><strong>It is not adjusted for seasonality.<\/strong>\u00a0The ICR can be affected by seasonal fluctuations in a company&#8217;s revenue and expenses. For example, a company that sells seasonal products may have a lower ICR in the off-season than in the peak season.<\/li>\n<li data-sourcepos=\"8:1-9:0\"><strong>It can be manipulated by companies.<\/strong> Companies can manipulate their ICR by taking on non-cash expenses, such as depreciation and amortisation. This can make the ICR look better than it actually is.<\/li>\n<\/ul>\n<p>Despite these limitations, the ICR is a useful metric for assessing a company&#8217;s ability to pay its interest expenses. However, it should be used in conjunction with other financial metrics to get a more complete picture of a company&#8217;s financial health.<\/p>\n<p style=\"text-align: center;\"><strong>Read more: <a href=\"https:\/\/razorpay.com\/blog\/business-banking\/accounting-ratios\/\">Accounting Ratio Analysis<\/a><\/strong><\/p>\n<p data-sourcepos=\"12:1-12:94\">Here are some other accounting ratios that can be used to assess a company&#8217;s financial health:<\/p>\n<ul data-sourcepos=\"14:1-19:0\">\n<li data-sourcepos=\"14:1-14:22\"><a href=\"https:\/\/razorpay.com\/learn\/business-banking\/debt-to-equity-ratio-explained\/\">Debt to equity ratio<\/a><\/li>\n<li data-sourcepos=\"15:1-15:22\">Debt to EBITDA ratio<\/li>\n<li data-sourcepos=\"16:1-16:25\">Cash flow to debt ratio<\/li>\n<li data-sourcepos=\"17:1-17:15\">EBITDA margin<\/li>\n<li data-sourcepos=\"18:1-19:0\">Return on equity (ROE)<\/li>\n<\/ul>\n<h4><b>Better Financial Management with RazorpayX<\/b><\/h4>\n<p>RazorpayX is helping India&#8217;s top businesses digitise their banking functions. Why do you need to digitise your business banking?<\/p>\n<ul>\n<li>Cut manual effort and mistakes with automated payouts, taxes and more<\/li>\n<li>A current account now directly integrated with your favourite accounting software<\/li>\n<li>Smart bulk payouts so you don&#8217;t have to worry about any missed payments<\/li>\n<li>Vendor management, payroll management &#8211; all in one place<\/li>\n<li>AI-driven financial insights with RazorpayX smart dashboard<\/li>\n<\/ul>\n<p style=\"text-align: center;\"><a style=\"border-radius: 3px; background: #528ff0; padding: 15px; font-weight: 600; cursor: pointer; text-decoration: none; color: white;\" href=\"https:\/\/razorpay.com\/x\/?r=blog_cta_business_banking_interest_coverage_ratio&amp;utm_source=blog&amp;utm_medium=cta\" target=\"_blank\" rel=\"noopener\" data-schema-attribute=\"\">Talk to an expert for free!<\/a><\/p>\n<p><strong>Read more:<\/strong><\/p>\n<p><a href=\"https:\/\/razorpay.com\/learn\/business-banking\/current-account-opening-documents-required\/\"><span style=\"font-weight: 400;\">Current Account Documents<\/span><\/a><\/p>\n<p><a href=\"https:\/\/razorpay.com\/blog\/business-banking\/what-is-current-account\/\"><span style=\"font-weight: 400;\">What is Current Account<\/span><\/a><\/p>\n<p><a href=\"https:\/\/razorpay.com\/learn\/business-banking\/what-is-a-business-account-for-startups\/\"><span style=\"font-weight: 400;\">Business Account<\/span><\/a><\/p>\n<p><a href=\"https:\/\/razorpay.com\/learn\/business-banking\/mab-monthly-average-balance-current-account\/\"><span style=\"font-weight: 400;\">Monthly Average Balance<\/span><\/a><\/p>\n<p><a href=\"https:\/\/razorpay.com\/blog\/business-banking\/zero-balance-current-account-business\/\"><span style=\"font-weight: 400;\">Zero Balance Current Account<\/span><\/a><\/p>\n<p><a href=\"https:\/\/razorpay.com\/learn\/business-banking\/types-of-current-accounts\/\"><span style=\"font-weight: 400;\">Types of Current Account<\/span><\/a><\/p>\n<h2><span class=\"ez-toc-section\" id=\"FAQs\"><\/span>FAQs<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\t\t\t<div id=\"rank-math-rich-snippet-wrapper\" class=\"\">\n\n\t\t\t\t\n\t\t\t<\/div>\n\t\t\n","protected":false},"excerpt":{"rendered":"<p>What is Interest Coverage Ratio?\u00a0 The interest coverage ratio (ICR) is a financial metric that measures a company&#8217;s ability to pay its interest expenses. It is calculated by dividing the company&#8217;s earnings before interest and taxes (EBIT) by its interest expense. A high ICR indicates that a company has a healthy financial position and is<\/p>\n","protected":false},"author":151156542,"featured_media":8737,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[3437],"tags":[2908,3703,3715,3716],"class_list":{"0":"post-8729","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-banking","8":"tag-accounting","9":"tag-accounting-ratio","10":"tag-interest-coverage-ratio","11":"tag-ratio-analysis"},"_links":{"self":[{"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/posts\/8729","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/users\/151156542"}],"replies":[{"embeddable":true,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/comments?post=8729"}],"version-history":[{"count":3,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/posts\/8729\/revisions"}],"predecessor-version":[{"id":10315,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/posts\/8729\/revisions\/10315"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/media\/8737"}],"wp:attachment":[{"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/media?parent=8729"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/categories?post=8729"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/learn.razorpay.in\/learn\/wp-json\/wp\/v2\/tags?post=8729"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}