Financial metric · Debt and liquidity
Interest Coverage Ratio
How many times a company's operating earnings cover its interest expense. The lower the multiple, the closer profit comes to falling short of the interest bill.
How to calculate it
Interest coverage = EBIT (earnings before interest and taxes) ÷ interest expenseEBITDA coverage = EBITDA ÷ interest expense (common in loan covenants)How to read it
- Below 1 means the year's earnings did not cover interest; the company has to borrow more or sell assets. Companies stuck below 1 for years are often called zombie companies.
- A high multiple (say, above 10) means interest is a light burden and earnings could fall a long way before debt service became a problem.
- Rising interest rates hit companies with floating-rate debt (common in leveraged loans) first. Check how much debt is fixed versus floating.
Common pitfalls
- Coverage measures the ability to pay interest, not to repay principal. Maturities are a separate question; see cash to short-term debt.
- Earnings are an accounting figure, but interest is paid in cash. A company with weak cash conversion has less real capacity than the multiple suggests.
- Interest capitalized into construction projects is not in interest expense, so companies in a build-out phase carry a heavier burden than reported.
- EBITDA-based coverage ignores capital spending. For capital-intensive companies, EBIT-based coverage is more conservative.
Where to find it in a 10-K
Income statement: operating income and interest expense (sometimes netted as 'interest expense, net'). The debt note discloses capitalized interest, and credit agreements filed as exhibits define the covenant ratios.
U.S. vs. China reporting
A-share income statements show finance costs that net interest income against interest expense, so take gross interest expense from the notes. U.S. companies more often show interest expense separately. Leveraged-loan covenants built on adjusted EBITDA are much more common in U.S. credit markets.