Term · Balance Sheet & Debt
Interest Coverage Ratio
In briefThe interest coverage ratio indicates how many times an earnings or cash-flow measure covers a period's net interest expense. For small caps with higher financing costs, low coverage makes them especially vulnerable in periods of rising rates.
Definition
The interest coverage ratio measures how many times an earnings or cash-flow measure covers the periodic net interest expense. The earnings definition used is not uniform.
How it is calculated
Formula. Commonly: EBIT ÷ net interest expense. Alternatively EBITDA or operating cash flow; the definition and sign convention must be disclosed.
Why it matters for small caps
In the small-cap segment companies often pay higher financing costs; low coverage makes them vulnerable in periods of rising rates.
Common misreadings
- EBIT- and EBITDA-based variants are compared directly. Capitalised interest, leases and variable rates can change the actual burden.
In the process
Frequently asked
What is the interest coverage ratio?
It shows how easily a company can bear its interest burden out of current earnings. A higher value means more buffer.
How is interest coverage calculated?
Commonly you divide EBIT by net interest expense; alternatively EBITDA or operating cash flow serve as the numerator. The chosen definition should be disclosed.
What is a source of error in interest coverage?
Metrics with EBIT, EBITDA or cash flow in the numerator are not readily comparable. In addition, capitalised interest, lease obligations and variable financing costs can make the reported buffer look better than it is economically.
Related terms
Sources
Primary
IFRS Foundation – IFRS 7 Financial Instruments: Disclosures
https://www.ifrs.org/issued-standards/list-of-standards/ifrs-7-financial-instruments-disclosures/
https://www.ifrs.org/issued-standards/list-of-standards/ifrs-7-financial-instruments-disclosures/
Methodology
IFRS Foundation – IFRS Accounting Standards Navigator
https://www.ifrs.org/issued-standards/list-of-standards/
https://www.ifrs.org/issued-standards/list-of-standards/
Education only, not investment advice. Ranges and thresholds are didactic orientation values, not an official standard.