This Interest Coverage Ratio template will guide you through the calculation of interest coverage ratio using an income statement.
Here is a screenshot of the template:
What is Interest Coverage Ratio (ICR)?
The Interest Coverage Ratio (ICR) is a financial ratio that is used to determine the ability of a company to pay the interest on its outstanding debt. The ICR is commonly used by lenders, creditors, and investors to determine the riskiness of lending capital to a company. The interest coverage ratio is also called the “times interest earned” ratio.
The lower the interest coverage ratio, the greater the company’s debt and the possibility of bankruptcy. Intuitively, a lower ICR indicates that less operating profits are available to meet interest payments and that the company is more vulnerable to volatile interest rates. Therefore, a higher interest coverage ratio indicates stronger financial health – the company is more capable of meeting interest obligations.
However, a high ICR may also indicate that a company is overlooking opportunities to magnify their earnings through leverage. As a rule of thumb, an interest coverage ratio above 2 is considered the minimum acceptable amount. In some cases, analysts would like to see an ICR above 3. An ICR below 1 indicates that a company is not able to pay off its current interest payment obligations and is therefore in poor financial health.
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