Fixed Charge Coverage Ratio Analysis

Definition: Fixed Charge Coverage Ratio is used to measure how well the firm covers their fixed costs such as interest expense and leases.

Formula:
Fixed Charge Coverage Ratio = (Earnings Before Interest and Taxes (EBIT)+ fixed charge) / (total interest + fixed charge)
Or,
Fixed Charge Coverage Ratio = (EBIT + Lease Expenses) / (Lease Expenses + Interest expense)

Example 1:
SK Ltd has $32,000 in EBIT, $2,000 in interest payments and $3,000 in lease payments.
Then,
Fixed charge coverage ratio = (32,000 + 3,000) / (3,000 + 2,000) = 7
This means that the company has earned seven times its fixed charges.

Example 2:
Pool Ltd earned $600,000 before interest and taxes for the fiscal year ending December 2010, and had an interest expense of $80,000 and lease expenses amounted to $20,000.
Then,
Fixed charge coverage ratio = (600,000 + 20,000) / (20,000 + 80,000) = 6.2

* Next: EBIT Formula & Example