Interest Coverage Ratio
Earnings before interest and taxes (EBIT) divided by interest expense. Sometimes called Times Interest Earned (TIE). Measures how many times operating earnings cover the firm's interest obligations.
When to use: Use to assess debt-service safety. Higher = more cushion. Investment-grade firms typically run >5; <2 is risky; <1 means operations don't cover interest at all (going-concern issue). Lenders watch this metric closely; covenant-laden debt agreements often specify minimum coverage levels.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| IC | Interest Coverage Ratio | EBIT / interest expense | integer |
| EBIT | EBIT | Earnings before interest and taxes (operating income) | $ |
| Interest | Interest Expense | Annual interest expense | $ |
Real-Life Examples
Example 1: Investment-Grade Firm
EBIT $400M, interest expense $50M.
Given
Step-by-Step
IC of 8.0 — operating earnings cover interest 8 times over. Comfortable, consistent with investment-grade debt ratings.
Example 2: High-Leverage Firm
EBIT $120M, interest expense $80M.
Given
Step-by-Step
IC of 1.5 — minimal cushion. A 33% drop in EBIT would mean missed interest. Typical of high-yield credits and PE-owned firms; pair with EBITDA-coverage and free-cash-flow coverage for a fuller picture.
Frequently Asked Questions
Both are reported. EBIT is the textbook standard; EBITDA-based "coverage" is common in lender disclosures because it adds back D&A (a non-cash charge). EBIT is more conservative; EBITDA gives a higher (more flattering) number.
Strict interest coverage uses interest only. "Fixed-charge coverage" extends the denominator to include preferred dividends and lease payments — a more comprehensive measure for firms with significant fixed obligations beyond interest.