Interest Coverage Ratio signifies the company company’s ability to pay interest on the outstanding debt. It is calculated to measure company’s profits in comparison to its interest obligation. ICR determines that how easily (or with difficulty) an entity can pay its interest obligation on the Debt.
The formula to calculate the interest coverage ratio is as under:
Earnings before Interest, Depreciation, Amortization and taxes (EBIDTA) ÷ Total interest expenses
The EBIDTA represent the Operating Profit before Depreciation, Interest and Amortization. In other words, it is the cash profit before accounting for interest and taxes.
Following is an excerpt of a Profit & Loss Account:
| Description | Amount |
|---|---|
| Sale | 100 |
| Other Expenses | 20 |
| Interest Expense | 25 |
| Depreciation | 30 |
| Profit Before Tax (PBT) | 25 |
| Tax | 10 |
| Profit after Tax (PAT) | 15 |
EBIDTA will be = PBT (25) + Depreciation (30) +Interest (25) = 80
Interest Coverage Ratio or ICR will be = EBIDTA (80) / Interest (25) = 3.20 times
It means that the cash profits (before interest) of the company can cover 3.20 times of its interest expense.
Higher the ICR, better the company’s position to pay its interest obligation.
Although ICR below 1.50 is not considered good, however, it should be atleast more than 1 so that company is able to meet its interest obligation. An Interest coverage ratio below 1 signify that the company is not able to serve its interest obligation as the interest is more than the cash profit.
ICR of 2 & above is considered good.
A company with lower ICR will have difficulty in meeting its interest obligation whenever the interest rates goes up.
Another way to calculate Interest coverage ratio is = EBIT / Interest. However, in our opinion the first method is more accurate measure. In the second method depreciation is also accounted for expense for calculating the entity’s interest paying capacity, while depreciation is not a cash expense.
As per AIBOC Circular dated 13.09.2023, the officers’ associations today, submitted a Supplementary Charter of…
Wage revision for bankers is due since November 2022, which is to be finalized through…
DA for Bankers is expected to increase for the quarter May 2023 to July 2023.…
If you're a banker, you know that staying up-to-date on industry trends and best practices…
DA for Bankers is increased for the quarter February 2023 to April 2023. CPI data…
12 Bipartite Settlement for revision of bank employees' salary and service conditions is due from…