Interest Coverage Ratio
EBIT relative to interest expense
What is Interest Coverage Ratio?
The Interest Coverage Ratio (also called Times Interest Earned) measures how comfortably a company can cover its interest expense from operating earnings. It is the primary measure of debt servicing ability and a key metric in credit analysis. A ratio above 3× is generally considered healthy; below 1.5× signals potential financial distress. Lenders and bond rating agencies scrutinise this ratio closely: a declining interest coverage ratio is an early warning sign that a company may struggle to refinance or service its obligations. During rising rate environments, companies with floating-rate debt will see their interest expense increase, compressing coverage ratios.
Formula
Interest Coverage = EBIT / Interest Expense
Cash Coverage = (EBIT + D&A) / Interest Expense
EBIT = Earnings Before Interest and Taxes (Operating Income)
Interest Expense = from income statement (not net of interest income)
Calculator
How to Use
- 1Find EBIT: Operating income from the income statement.
- 2Find interest expense: From the income statement, below operating income. Use gross interest expense, not net.
- 3Divide: EBIT ÷ Interest Expense. A result of 5× means earnings cover interest 5 times over.
- 4Trend matters: A ratio declining from 8× to 3× over three years is more alarming than a stable 3× ratio.
Worked Example
Example: Manufacturing company
EBIT
$600M
Interest Expense
$120M
Coverage = $600M / $120M = 5.0×. Solid: earnings cover interest five times. In a severe recession where EBIT falls 40% to $360M, coverage drops to 3×, which is still acceptable but leaves limited buffer. A company with only 2× coverage in normal times has almost no recession buffer.