What is the ‘EBITDA-To-Interest Coverage Ratio’
The EBITDA-to-interest coverage ratio is a ratio that is used to assess a company’s financial durability by examining whether it is at least profitably enough to pay off its interest expenses. A ratio greater than 1 indicates that the company has more than enough interest coverage to pay off its interest expenses. This ratio is also known as EBITDA coverage.
The ratio is calculated as follows:
Explaining ‘EBITDA-To-Interest Coverage Ratio’
This ratio was first widely used by leveraged buyout bankers, who would use it as a first screen to determine whether a newly restructured company would be able to service its short-term debt obligations. While this ratio is a very easy way to assess whether a company can cover its interest-related expenses, the applications of this ratio are also limited by the relevance of using EBITDA as a proxy for various financial figures. For example, suppose that a company has an EBITDA-to-interest coverage ratio of 1.25; this may not mean that it would be able to cover its interest payments, because the company might need to spend a large portion of its profits on replacing old equipment. Because EBITDA does not account for depreciation-related expenses, a ratio of 1.25 might not be a definitive indicator of financial durability.
EBITDA-To-Interest Coverage Ratio Calculation and Example
There are two formulas used for the EBITDA-to-interest coverage ratio that differ slightly. Analysts may differ in opinion on which one is more applicable to use depending on the company being analyzed. They are as follows:
- Costs of financial distress and interest coverage ratios – onlinelibrary.wiley.com [PDF]
- Ebitda/Ebit and cash flow based ICRs: a comparative approach in the agro-food system in Italy – journals.muni.cz [PDF]
- Corporate financial distress: The case of publicly listed firms in an emerging market economy – onlinelibrary.wiley.com [PDF]
- The Finances of China's Enterprise Sector – books.google.com [PDF]
- Zombie firms in Italy: a critical assessment – papers.ssrn.com [PDF]
- How costly is financial (not economic) distress? Evidence from highly leveraged transactions that became distressed – onlinelibrary.wiley.com [PDF]
- Financial and income approach analysis in micro (MEs) and small/medium sized enterprises (SMEs): A comparative approach in fruit and vegetables processing … – academicjournals.org [PDF]