The interest coverage ratio (ICR) is a financial ratio that measures a company’s ability to handle its outstanding debt.
The ratio is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense. A low ICR indicates that the company’s debt is great and, therefore, so is the possibility of bankruptcy. A higher ICR indicates stronger financial health.
Interest Coverage Ratio (ICR)
The Interest Coverage Ratio (ICR) is a financial metric used to measure a company’s ability to pay interest on its outstanding debt. It indicates how easily a company can cover its interest expenses with its earnings before interest and taxes (EBIT). A higher ICR means the company is more capable of paying interest on its debt, while a lower ratio may signal financial distress.
Formula for Interest Coverage Ratio (ICR)
The formula for calculating the Interest Coverage Ratio is:
ICR=EBITInterest Expenses{ICR} = \frac{EBIT}}{{Interest Expenses}}
Where:
- EBIT (Earnings Before Interest and Taxes): The company’s earnings before deducting interest expenses and taxes. It reflects the company’s ability to generate income from operations.
- Interest Expenses: The amount the company has to pay on its outstanding debt during a given period (usually a year).
How to Calculate ICR
Find the EBIT:
EBIT=Revenue−Operating Expenses(excludinginterestandtax)\text{EBIT} = \text{Revenue} – \text{Operating Expenses} (excluding interest and tax)
This can be found on the company’s income statement or calculated as:Determine the Interest Expenses:
This is the total interest the company needs to pay on its debt, also found on the income statement.Divide EBIT by Interest Expenses:
Once you have both values, divide EBIT by the interest expenses to find the ICR.
What Does ICR Tell Us?
Higher ICR:
A higher ratio indicates the company has sufficient income to cover its interest payments. This is a positive sign and suggests the company is not overburdened by debt. Generally, an ICR of 3 or more is considered healthy.Lower ICR:
A lower ratio suggests the company might struggle to meet its interest obligations, signaling potential financial stress or a higher risk of defaulting on debt. A ratio below 1 indicates the company is not generating enough income to cover its interest expenses.
What is a Good ICR?
- An ICR of 1 means the company’s EBIT is exactly equal to its interest expenses, meaning it can cover interest payments but does not have much margin for error.
- An ICR of 3 or more is generally considered good because it shows the company can pay its interest three times over with its operational earnings.
- ICRs below 1 indicate the company may be in trouble, as it’s not generating enough earnings to meet its interest payments.
Typical Benchmarks:
- High ICR (above 3): Indicates a strong financial position and the company can easily manage debt obligations.
- Low ICR (1-2): Indicates a moderate risk, where the company may face difficulties if there are declines in earnings.
- Very low or Negative ICR (below 1): Indicates a high risk of default, and the company may need to restructure its debt or find additional funding.
FAQs
What is the Interest Coverage Ratio (ICR)?
The Interest Coverage Ratio (ICR) is a financial metric used to determine how easily a company can pay interest on its outstanding debt. It measures the company’s ability to meet its interest obligations from its operating income (EBIT or Earnings Before Interest and Taxes). A higher ICR indicates better ability to cover interest payments.
What is the ideal Interest Coverage Ratio?
An ideal Interest Coverage Ratio (ICR) is typically considered to be greater than 3. This means that the company earns more than three times its interest expense from operating profits, signaling strong financial health. However, the acceptable ratio may vary depending on the industry and business type.
Practice area's of B K Goyal & Co LLP
Income Tax Return Filing | Income Tax Appeal | Income Tax Notice | GST Registration | GST Return Filing | FSSAI Registration | Company Registration | Company Audit | Company Annual Compliance | Income Tax Audit | Nidhi Company Registration| LLP Registration | Accounting in India | NGO Registration | NGO Audit | ESG | BRSR | Private Security Agency | Udyam Registration | Trademark Registration | Copyright Registration | Patent Registration | Import Export Code | Forensic Accounting and Fraud Detection | Section 8 Company | Foreign Company | 80G and 12A Certificate | FCRA Registration |DGGI Cases | Scrutiny Cases | Income Escapement Cases | Search & Seizure | CIT Appeal | ITAT Appeal | Auditors | Internal Audit | Financial Audit | Process Audit | IEC Code | CA Certification | Income Tax Demand Notice | Psara License | FCRA Online
Company Registration Services in major cities of India
Company Registration in Jaipur | Company Registration in Delhi | Company Registration in Pune | Company Registration in Hyderabad | Company Registration in Bangalore | Company Registration in Chennai | Company Registration in Kolkata | Company Registration in Mumbai | Company Registration in India | Company Registration in Gurgaon | Company Registration in Noida | Company Registration in lucknow
Most read resources
tnreginet |rajssp | jharsewa | picme | pmkisan | webland | bonafide certificate | rent agreement format | tax audit applicability | 7/12 online maharasthra | kerala psc registration | antyodaya saral portal | appointment letter format | GST Search Taxpayer | caro 2020 | Challan 280 | itr intimation password | internal audit applicability | preliminiary expenses | mAadhar | e shram card | aaple sarkar portal | epf activation | scrap business | brsr | depreciation on computer | west bengal land registration | traces portal | Directorate general of GST Intelligence | form 16 | rtps | patta chitta