What is the ratio of interest coverage?
Interest coverage ratio measures the financial effect of the company by calculating its ability to pay interest on its loans. This ratio is calculated by distributing the income of the company - before the interest and tax model - according to the amount of interest that the company has to pay in a given period of time. The higher the ratio, the better the company will last financial unrest because of capital it has in reserve. If the ratio drops below the basic level of one, it means that society's solvency is at risk because it has lost its ability to cover its interest payments. Interest payments come with loans and a financially stable company must generate enough income to make these payments not only, but also enough in the reserve to withstand either a sudden decline or a prolonged abyss in the Revenue. The interest coverage ratio provides a good measuring stick for this type of financial stability, making it an important tool for those who try to decide on the viability of a potential investment.
In order to calculate the interest coverage coverage ratio, income before interest and tax or EBIT must be calculated. This number is divided by total interest fees collected in the company. The numerator and the denominator in this equation must be taken from the same time period to ensure the reliability of the ratio as the evaluator of the company's financial force.
When analyzing interest coverage ratio, it is important to determine the level of benchmark for what is considered an acceptable ratio. The 1.5 ratio is often cited as a standard minimum level for a viable company. This level could occasionally be adjusted depending on the type of business analyzed. For example, if the company has a constant flow of income, the ratio may not be extremely high. The company in the industry that is experiencing high volatility would probably need a higher interest ratio to endure the fluctuations.
It is also important to realize that the ratio of interest coverage is best used as an indicator of financial SA vineys, when it is studied for a long time, which gives enough freedom for any short -term peaks and valleys to equalize. Those who want an even stricter measuring stick can replace EBIT in the equation of earnings before interest or EBI. This would reflect the taxes that the company has to pay and provide a more true account of how much financial leverage it has.