What is Interest Coverage Ratio?
Nexa Consultancy | Startup & Finance Glossary
The Interest Coverage Ratio is a debt and profitability ratio used to determine how easily a company can pay the interest on its outstanding debt. It measures the margin of safety a company has for paying its interest expense from its operating income.
For Startups: This ratio is particularly important for startups that have taken on venture debt or other loans. A low ratio indicates that the company is at a higher risk of defaulting on its interest payments if its earnings decline. Lenders look for a ratio of at least 1.5, and preferably above 2.0, to feel comfortable.
Calculation: Interest Coverage Ratio = EBIT (Earnings Before Interest and Taxes) / Interest Expense.
Example: A company has an EBIT of ₹50 Lakhs and an annual interest expense of ₹10 Lakhs. Its interest coverage ratio is 5, indicating it can cover its interest payments five times over from its operating profit.