Interest Coverage Ratio

Finance

Quick Definition

Interest Coverage Ratio (ICR) is a financial ratio that measures a company’s ability to pay interest on its outstanding debt using its earnings.

Detailed Explanation

Interest Coverage Ratio shows how comfortably a company can meet its interest obligations. It compares earnings before interest and taxes (EBIT) with interest expenses.

A higher ratio indicates that the company is in a strong financial position, while a lower ratio signals potential difficulty in paying interest.

Formula

👉 Interest Coverage Ratio = EBIT ÷ Interest Expense

Interpretation

  • > 3: Strong financial health
  • 1.5 – 3: Moderate risk
  • < 1.5: High risk
  • < 1: Cannot cover interest obligations

Why Interest Coverage Ratio Matters

  • Assesses debt repayment ability
  • Important for lenders and investors
  • Indicates financial stability

Limitations

  • Does not include principal repayment
  • Depends on accounting earnings

Example

"If a company has EBIT of ₹10 lakh and interest expense of ₹2 lakh: 👉 ICR = 5 (strong position)"

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