Can the company afford its debt?
The interest coverage ratio measures how comfortably a company’s operating earnings can pay the interest on its debt. Lenders, bond investors and credit rating agencies use it as a first test of financial strength.
Interest coverage = operating income (EBIT) ÷ interest expense
A ratio of 5 means the company earns five times what it owes in interest each year.
Worked example
A company has $2,000,000 of operating income, $500,000 of depreciation and amortization, and $400,000 of interest expense:
| Result | Value |
|---|---|
| Interest coverage (EBIT) | 5.00× |
| EBITDA coverage | 6.25× |
| Fall in EBIT before interest is uncovered | 80% |
| Maximum interest for a coverage of 3 | $666,667 |
Operating income could fall by 80% before it no longer covers the interest, a comfortable cushion. The company could also take on more debt: at a coverage of 3, it could carry up to about $667,000 of annual interest.
What counts as good?
| Coverage | Reading |
|---|---|
| Below 1 | Earnings do not cover interest |
| 1 to 1.5 | Fragile; a small downturn could cause trouble |
| 1.5 to 3 | Acceptable but limited headroom |
| 3 or more | Comfortable |
| 8 or more | Very strong, typical of top credit ratings |
Benchmarks depend on the industry. Utilities with stable, regulated revenues often run with coverage of 2 to 3, while cyclical businesses such as construction or airlines need more to survive bad years.
EBIT or EBITDA?
EBIT coverage is the stricter measure, because depreciation reflects the real cost of replacing equipment. EBITDA coverage is higher and is common in loan covenants, often paired with a maximum ratio of net debt to EBITDA. Asset-heavy businesses can look healthy on EBITDA while struggling to fund both interest and capital expenditure.
Related ratios
- Debt service coverage ratio (DSCR): includes principal repayments, not just interest, and is the main test for real estate and project loans.
- Fixed-charge coverage: adds lease payments to interest.
- Net debt to EBITDA: measures how many years of earnings it would take to repay the debt.
Limits
The ratio uses one year of earnings, which can be unusually high or low. Variable-rate debt means interest can rise quickly when rates go up. Look at the trend over several years and at the cash flow statement, not just the income statement.
This calculator gives estimates for education and planning. It is not investment, tax or legal advice; for decisions about your own situation, talk to a qualified financial professional.