What Is an Interest Cover?

Interest coverage ratio (interest coverage ratio), also known as interest coverage ratio, is the ratio of profit before interest and tax earned by an enterprise's production and operation to interest expenses. It is an indicator to measure the long-term debt service ability of an enterprise. The larger the interest protection multiple, the stronger the company's ability to pay interest expenses. Therefore, creditors should analyze the index of interest protection multiples to measure the security of debt capital.

Interest coverage ratio

Interest coverage multiples =

The indicator of interest protection multiples reflects how many times the operating income of an enterprise is the interest on the debt that needs to be paid. As long as the interest protection multiple is large enough, the enterprise has sufficient ability to pay interest, and vice versa.

The focus of the interest protection multiple is to measure the ability of an enterprise to pay interest. Without a sufficiently large profit before interest and tax, it will be difficult to pay interest.

The interest protection multiple not only reflects the size of the company's profitability, but also reflects the degree of profitability's guarantee for repayment of due debts.

In order to examine the stability of the company's ability to pay interest, it is generally necessary to calculate the interest protection multiple for 5 years or more. For the sake of conservativeness, the lowest interest protection multiple in five years should be selected as the basic indicator of interest solvency.

Regarding the calculation of this indicator, the following points should be noted:

(1) Analyze the ability of an enterprise to repay its debts according to the profit and loss statement. As the "numerator" of interest payment protection, it should only include current income.

(2) Cumulative effects of special items (such as fire damage, etc.), suspension of operations, and changes in accounting policies.

(3) Interest expenses include not only interest expenses reflected as current expenses, but also capitalized interest expenses.

(4) Equity income that has not received cash dividends may be deducted.

(5) When there are subsidiaries with less than 100% equity but need to be consolidated, the minority equity income should not be deducted.