Fixed-Charge Coverage Ratio Formula and Example

A fixed-charge coverage ratio (FCCR) is a financial ratio that appears on a company’s balance sheet. The ratio compares the company’s earnings to the various fixed payments that are part of its operating expenses. Examples of these fixed payments include:

• Real estate charges: This category includes lease payments, mortgage payments, mortgage interest, and related fees.
• Insurance payments: This category includes insurance premiums, but it would not include deductibles that factor in when filing a claim.
• Interest payments: Companies frequently incur interest expenses. Some are part of their broader lease expenses, but they also include interest owed to lenders who have extended a business loan.
• Loan repayments: In addition to interest payments, a company (as a borrower) must steadily repay the principal of its business loans. Any other type of debt repayment will also factor into a company’s fixed-charge coverage ratio.
• Taxes: Nearly all companies, whether large corporations or small businesses, must pay a certain amount of tax. This may include income tax, annual business taxes, and remitted sales tax.

A fixed-charge coverage ratio compares company revenue to the fixed charges the business will incur regardless of its financial fortunes. To calculate this, business owners and accountants use the following formula:

(EBIT + FCBT) / (FCBT + Interest)

This formula makes use of the following inputs.

• EBIT is earnings before interest and taxes. This should not be confused with EBITDA which stands for earnings before interest, taxes, depreciation, and amortization. This goes in the numerator of the FCCR.
• FCBT is fixed charges before taxes. This goes in the numerator of the FCCR, where it is added to EBIT, as well as the denominator, where it is added to interest.
• Interest is the sum of all interest payments. This item represents various forms of interest that appear on a company’s financial statements.

Financial analysts use the FCCR to estimate a firm’s ability to pay its mandatory bills. A higher ratio indicates that the company’s profits outstrip its financial obligations. A lower ratio suggests that financial obligations may be outpacing cash flow, and this leads to questions about the company’s ability to pay its debts.

To see this in action, imagine a shoe company that reports an EBIT of $32.1 million on its income statement. It also has $26 million in fixed charges and $14 million in fixed interest expenses. When you plug these values into the FCCR formula, you get a fixed-charge coverage ratio of 1.425. This means the company’s annual income outpaces its fixed costs. It’s a relatively decent solvency ratio, but the company would probably think twice about taking on additional debt without changing its pricing structure. Note that most financial analysts consider a company to be quite stable when its FCCR is over 2.0. The hypothetical shoe company does not have such a high ratio, but it is nonetheless a solvent business.

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