How to Calculate Interest Coverage Ratio

The Interest Coverage Ratio is a financial ratio used to measure the amount of profit available to cover the firm's interest expense. A lower ratio indicates that the company has less earnings to meet its interest payments. The ratio can be calculated as follows:

Interest Coverage Ratio = Net Profit Before Interest and Tax / Interest Payable

Learn how to calculate the ratio with the following example:

Silver Ltd has the following information:
Sales revenue: $900,000
Cost of sales: $400,000
Rates: $7,000
Salaries: $55,000
Insurance: $10,000
Heat and light: $3,500
Postage and telephone: $800
Depreciation of motor vehicles: $3,000
Depreciation of freehold buildings: $2,000
Interest payable: $35,000

Therefore,
Gross profit = Sales revenue - Cost of sales = 900,000 - 400,000 = $500,000
Total expenses (exclude interest payable) = 7,000 + 55,000 + 10,000 + 3,500 + 800 + 3,000 + 2,000 = $81,300
Net profit before interest and taxation = Gross profit - Total expenses = 500,000 - 81,300 = $418,700

Interest Coverage Ratio = 418,700 / 35,000 = 11.96 times

* Next: How To Calculate Gearing Ratio