Fixed-Charge Coverage Ratio (FCCR)

What is the Fixed-Charge Coverage Ratio (FCCR)?

The Fixed-Charge Coverage Ratio (FCCR) is a measure of a company’s ability to meet fixed-charge obligations such as interest expensesInterest ExpenseInterest expense arises out of a company that finances through debt or capital leases. Interest is found in the income statement, but can also be calculated through the debt schedule. The schedule should outline all the major pieces of debt a company has on its balance sheet, and calculate interest by multiplying the and lease expensesOperating LeaseAn operating lease is an agreement to use and operate an asset without ownership. Common assets that are leased include real estate, automobiles, or equipment. By renting and not owning, operating leases enable companies to keep from recording an asset on their balance sheets by treating them as operating expenses.. The FCCR is a broader measure of the times interest coverage ratio, more complete by virtue of the fact that it also includes other fixed costsFixed and Variable CostsCost is something that can be classified in several ways depending on its nature. One of the most popular methods is classification according to fixed costs and variable costs. Fixed costs do not change with increases/decreases in units of production volume, while variable costs are solely dependent such as leases and insurance. As  with other commonly used debt  ratios, a higher ratio value  – preferably 2 or above – indicates a more financially healthy, and less risky, company or situation. A lower ratio value – less than 1 – indicates that the company is struggling to meet its regularly scheduled payments.

Fixed-Charge Coverage Ratio Formula

The formula for calculating the fixed-charge coverage ratio is as follows:     

Where:

• EBITEBIT GuideEBIT stands for Earnings Before Interest and Taxes and is one of the last subtotals in the income statement before net income.  EBIT is also sometimes referred to as operating income and is called this because it's found by deducting all operating expenses (production and non-production costs) from sales revenue. stands for earnings before interest and taxes.
• Fixed charges are regular, business expenses that are paid regardless of business activity. Examples of fixed charges include debt installment payments, business equipment lease payments, and insurance premiums.

Example of Fixed-Charge Coverage Ratio

Jeff operates a salon in the city of Vancouver. The salon’s monthly expenses include lease payments of $5,000, insurance costs for the salon at $1,000, and insurance costs for the company’s work vehicle at $500. Jeff’s salon generated EBIT of $500,000, and has an annual interest expense of $50,000. The fixed-charge coverage ratio for Jeff’s salon would be calculated as follows:

1. Converge monthly fixed-charges to annual amounts:

• Monthly lease payments of $5,000 x 12 = $60,000 annually
• Monthly insurance costs of the salon: $1,000 x 12 = $12,000 annually
• Monthly insurance costs of the car: $500 x 12 = $6,000 annually

Therefore, annual fixed-charges equate to $60,000 + $12,000 + $6,000 = $78,000

2. Apply the FCCR formula:

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Interpretation of the Fixed-Charge Coverage Ratio

The FCCR is used to determine a company’s ability to repay its fixed payments. In the example above, Jeff’s salon would be able to meet its fixed payments 4.51 times. The fixed-charge coverage ratio is regarded as a solvency ratio because it shows the ability of a company to repay its ongoing financial obligations when they are due. If a company is unable to meet its recurring monthly or annual financial obligations, then it is in serious financial distress. Unless the situation is remedied quickly, efficiently, and safely, it is unlikely that the company will be able to remain financially afloat for very long.

Here is a way to evaluate the FCCR number:

• An FCCR equal to 2 (=2) means that the company can pay for its fixed charges two times over.
• An FCCR equal to 1 (=1) means that the company is just able to pay for its annual fixed charges.
• An FCCR less than 1 (<1) means that the company lacks enough money to cover its fixed charges.

Therefore, generally speaking, the higher the fixed-charge coverage ratio value, the better, as this indicates a company operating on solid financial ground, with adequate revenues and cash flows to meet its regular payment obligations.

The FCCR is often used by lenders or market analysts to assess the sufficiency of a company’s cash flows to handle the company’s recurring debt obligations and regular operating expenses.

Fixed-Charge Coverage Ratio and the Times Interest Earned Ratio

The fixed-charge coverage ratio is similar to the more basic “times interest earned ratio”, another debt or financial solvency ratio that uses earnings before interest and taxes (EBIT) to determine a company’s ability to successfully handle its debt obligations.

Compare the times interest earnedInterest Coverage RatioInterest 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 “times ratio formula shown below with the formula for the fixed-charge coverage ratio as shown above.

You may want to view the FCCR as a more conservative assessment of a company’s financial health because it takes into consideration additional fixed charges besides just interest payments, such as leases and insurance.

Other Resources

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