Interest Coverage Ratio — Investment Wiki

The Interest Coverage Ratio mathematically verifies how easily a company can pay the interest expenses on its outstanding debt. It is a critical counterpart to the Debt-to-Equity ratio for testing bankruptcy risk during high-interest-rate environments.

Quick Reference

Type	Solvency / Leverage Ratio
Formula	Operating Income (EBIT) ÷ Interest Expense
Safe Target	> 3.0x
Bankruptcy Risk	< 1.5x

1.0 The Formula

Basic Form

formulaInterest Coverage Ratio = EBIT / Interest Expense

A ratio of 3.0 means that the company generates exactly three times enough operating profit to cover its interest payments.

This ratio is heavily impacted by interest rates. A company holding adjustable-rate debt will see its Interest Expense skyrocket during inflationary cycles, causing its Interest Coverage Ratio to plummet overnight even if its core operations are fine.

2.0 Interpretation & Edge Cases

Companies with sustained Interest Coverage Ratios below 1.5x are colloquially known as "Zombie Companies." They earn just enough to scrape by paying the interest on their loans, but they never earn enough to pay down the actual principal. The moment a shock hits their revenue, they default.

3.0 Related Pages

Debt-to-Equity Ratio

Must be used together. A high Debt-to-Equity is incredibly dangerous if accompanied by a low Interest Coverage Ratio.