Interest Coverage Ratio (ICR)

Often known as “times interest earned”, the Interest Coverage Ratio (ICR) is a financial measure used to assess how quickly a business will pay interest on its outstanding debts. ICR can be determined by dividing the earnings of a company before interest and taxes (EBIT) by the interest payments due over the same period within a given period. The ICR is widely used by lenders, creditors, and investors to assess a company’s risk of loaning money.

This calculation is also used by lenders, investors, and creditors to see the riskiness of a company relative to its existing debt or possible borrowings. Hence, interest coverage ratio comparisons are only valid when involving companies within one industry and ideally with business models and revenues that aren’t too diverse. The next coverage ratio is healthier, although the perfect ratio may vary by industry.

Interest Coverage Ratio (ICR) Formula:

Interest Coverage Ratio = EBIT / Interest Expense

Where:

EBIT = Earnings before interest and taxes

Interest expense represents the interest payable on any borrowings such as bonds, loans, lines of credit, etc.

The interest coverage ratio (ICR) calculates how many times a firm with its available earnings will cover its current interest payment. When looking at the self-published interest coverage ratio of a corporation, it is necessary to check whether or not all debts were already part of the estimates, or whether the interest coverage ratio needs to be separately calculated. In other words, it tests the margin of protection a corporation has over a specified time for paying interest on its debt.

In the event that the premium inclusion proportion is at any rate equivalent to 1, it implies the organization is winning only enough to manage the cost of its advantage. It is utilized to decide how effectively an organization can pay its advantage costs on a remarkable obligation. The proportion is determined by separating an organization’s profit before intrigue and assessments (EBIT) by the organization’s advantage costs for a similar period. In the computation, EBIT is utilized as opposed to net gain to give the most precise image of what the organization can bear to pay in intrigue. If the interest coverage ratio of an organization is just 1.5 or lower, the ability to meet interest expenditures can be doubtful.

An interest coverage ratio (ICR) is not always as simple as it would appear. It depends a lot on how comfortable the borrower or lender is with the degree of risk, but in any case, the fundamentals of the calculation are the same. An aspect of its solvency is the ability of a company to meet its interest obligations and is, therefore, a very important factor in shareholder returns. ICR also says lots a few businesses present financial states, but studying interest coverage ratios within a period of your time usually offers a more accurate picture of the company’s present position and future direction.

Interest Coverage Ratio (ICR) example, Company ABC announced total sales of $10,000,000 with $500,000 of COGS (cost of goods sold). In addition, operating expenses were $120,000 in wages, $500,000 in rent, $200,000 in services, and $100,000 in depreciation in the most recent reporting period. For the time the interest rate is $3,000,000.

In general, one of the most important things to look for when evaluating the interest coverage ratio in this way is consistency in interest coverage ratios. It is a very good way to determine the short-term fiscal health of an organization. A decreasing interest coverage ratio is also something to look out for investors, as it means a company will not be able to pay its debts in the future. Sizing up an investment opportunity is possible by examining the past of a company’s interest coverage ratio. But it is hard to rely on any ratio or metric to predict the long-term financial state of a company.

 

Information Sources:

  1. studyfinance.com
  2. corporatefinanceinstitute.com
  3. investopedia.com