Interest Coverage Ratio: ICR Formula and Calculation

Interest coverage ratio is a financial ratio that measures a company’s ability to make interest payments on its outstanding debts. Sometimes known as the times interest earned (TIE) ratio, accountants, investors, and lenders reference this figure to predict whether or not a company has enough operating income to meet its financial obligations over time. A company’s ability to cover its debts and expenses related to this figure can reflect its solvency (or long-term financial health and ability to generate revenue) and liquidity (or short-term financial health and ability to cover expenses).

The interest coverage ratio (or ICR) number represents how many times a company’s total revenue for a given period can cover the interest on its current debts. A lower interest coverage ratio may mean that a company doesn’t have enough revenue to cover its debt obligations. On the other hand, a higher interest coverage ratio suggests that a company has plenty of revenue to cover its debt ratios.

A good interest coverage ratio is above two or two and a half. In contrast, an interest coverage ratio of one and a half and below means that the company will have trouble paying its debt obligations.

Accountants and investors use interest coverage ratios to evaluate a company’s short- and long-term financial health. Lenders use this financial ratio as a litmus test to determine if a company will be able to pay back the debt on a prospective loan.

Lenders may also use a company’s ICR to determine the interest rate on any requested loans. Businesses also use similar financial ratios to decide whether they are taking full advantage of debt opportunities or taking on too much debt.

The simple formula for interest coverage ratio is ICR = EBIT (earnings before interest and taxes)/ interest expense. Here’s how to calculate the interest coverage ratio:

1. 1. Identify the EBIT. First, find the company’s earnings before interest and taxes (EBIT). This figure represents the company’s total operating profit, or the amount of working capital they have to cover operating expenses. The EBIT is a line item on a company’s income statement.
2. 2. Determine interest expense. Determine the company's interest expense, which is the interest payable on borrowings such as lines of credit, bonds, or loans. The company’s total interest expense usually appears on its income statement for the given period. This number does not include the total debt repayment for a company, which you can find on a company’s balance sheet.
3. 3. Divide EBIT by interest. Divide the company’s EBIT by the company’s interest expense to get the interest coverage ratio.

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