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 expenses and lease 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 costs 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:
- EBIT 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 earned 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.
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