Interest Coverage Ratio Calculator

Earnings are not cash

EBIT is an accounting figure. Interest is paid in money. The ratio compares one to the other and quietly assumes they are the same thing.

They are not. EBIT includes revenue that has been invoiced and not yet collected, so a business whose receivable days are lengthening reports stable earnings while less and less of them arrive as cash. It excludes movements in working capital entirely, so a company building inventory ahead of a season shows unchanged cover while its bank balance falls.

It also excludes tax and capital expenditure, both of which are real and both of which compete with interest for the same cash.

The consequence: a company can post 4× cover for several periods while steadily running out of money. Interest cover is an earnings test and it should be read as one — a measure of whether the business is profitable enough to carry its debt, not of whether it has the cash this quarter.

It cannot see the principal

This is the larger omission, and it is structural rather than a matter of degree.

Interest cover puts the interest charge in the denominator and stops. Nothing in it knows that a loan amortises, or that a bullet repayment falls due next quarter. A company can cover its interest four times over and be entirely unable to make a scheduled repayment, and the ratio will report 4× right up until the default.

On the figures loaded in the tool, the same earnings cover interest 6.0× and full debt service 1.67×. Both are correct. Only the second describes what actually has to leave the bank account, and it is the one a lender will test.

That is why the tool renders the debt service figure inline rather than merely mentioning it: the gap between the two numbers is the point, and it is large on almost any amortising facility. The DSCR calculator covers the covenant side properly, including the headroom before a breach.

Where interest cover genuinely earns its place is as a trend. Falling cover across several periods is an early signal that the debt burden is growing relative to the earnings carrying it, and it shows up there before it shows up in a coverage test.

EBIT or EBITDA?

Both versions are in use, they differ by depreciation and amortisation, and the difference is not small for anything capital-intensive.

EBITDA cover is always the larger number. Adding back a non-cash charge can only increase the numerator. On the tool’s figures the same company covers 4.0× on EBIT and 6.0× on EBITDA — a fifty per cent improvement from an accounting adjustment.

The argument for EBITDA is that depreciation is not a cash cost, so it should not be deducted before testing whether cash-paying interest is affordable. The argument against is that depreciation is a proxy for the capital expenditure a business must eventually make to keep operating, and ignoring it flatters exactly the businesses that most need to reinvest.

For a software business the two are close. For an airline, a manufacturer or a utility they are far apart, and the choice of basis materially changes the verdict.

Which is why covenants name one. If the agreement says EBITDA, the EBIT figure is informative but not the test; if it says EBIT, adding depreciation back is not conservatism, it is the wrong measure. The tool reports both so the two are never confused.

The interest it does not count

The denominator is the interest expense in the income statement, and that is not necessarily all the interest the company incurred.

When borrowing funds the construction of a qualifying asset — a building, a ship, a plant that takes a substantial period to get ready — the interest is capitalised into the cost of that asset rather than expensed. It is a real cash cost, it is being paid to a lender, and it does not appear in the ratio’s denominator at all.

For a business in a heavy build phase this can be a large share of total interest, and it makes reported cover look considerably better than the cash position warrants. A property developer mid-project is the clearest case: much of its interest sits in work-in-progress.

The capitalised amount is disclosed in the notes to the accounts, and a careful analyst adds it back to the denominator. Many published coverage figures do not, which is one reason two people can compute different cover for the same company from the same accounts.

The same applies in reverse to interest income. Some conventions test net interest, which raises cover for a company holding significant cash. Again, the facility agreement decides.

What lenders look for

There is no universal threshold, but the ranges are reasonably well established and the reasoning behind them is more useful than the numbers.

Below 1.5× is uncomfortable almost anywhere. There is very little room for earnings to fall before the interest itself is at risk, and earnings do fall.

Around 2× is where covenants commonly sit for leveraged borrowers. Between 3× and 5× is unremarkable for a stable trading business.

Very high cover is not automatically good news. A company covering interest forty times over is barely using debt at all, which may be prudent or may be capital sitting idle where cheap borrowing would fund growth. Read it beside debt-to-equity before concluding either.

The threshold that actually matters is the one written into the facility, and it will be defined precisely — which earnings measure, which interest, tested over what period, with which adjustments. A generic benchmark is a sanity check, not a compliance test.

Sector matters as much as level. Utilities operate at low cover by design because their cash flows are regulated and predictable; a cyclical manufacturer at the same cover would be carrying far more risk.

What interest cover cannot tell you

Three limits beyond the two already covered.

It is blind to the rate resetting. Cover computed at today’s interest charge says nothing about a floating-rate facility repricing next year. The denominator is historical; the risk is forward.

A negative result is meaningful and often mishandled. A loss-making company has negative interest cover, which is a real statement about how far short earnings fall — not an error, and not something to display as zero. This tool reports the negative figure.

It says nothing about the maturity profile. Comfortable cover with the whole facility maturing in six months is a refinancing problem, and refinancing risk is where coverage ratios are least informative.

Read it as one of three tests — how much debt there is, whether earnings carry it, and whether cash can service it — rather than as an answer on its own.

Sources and methodology

The definitions behind both sides of the ratio.

• SEC Regulation S-X §210.5-03 — the prescribed income-statement format, which keeps interest expense as its own line
• IAS 23 Borrowing Costs — the standard requiring interest on qualifying assets to be capitalised rather than expensed
• IAS 1 Presentation of Financial Statements — what appears in profit or loss and in what order
• ACCA Financial Management technical articles — interest cover and covenant analysis in the professional syllabus
• How we calculate — methodology

Method. A negative EBIT produces a negative cover ratio rather than a null or a zero, and that is asserted as a case — a loss-making company’s shortfall is exactly the situation the ratio is being consulted about, and reporting it as “no data” would hide it. Zero interest returns no ratio at all, because a company with no interest has no coverage ratio, which is a different statement from having an excellent one. The property that EBITDA cover never falls below EBIT cover is fuzzed over four thousand generated income statements rather than assumed. The engine is verified on every change against 87 assertions shared with the rest of the solvency cluster. The count and the per-case breakdown are published on the formula verification page.

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The other two questions about the same debt:

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