Interest Coverage Ratio

The Interest Coverage Ratio (ICR) is a vital financial metric that helps investors, lenders and business owners evaluate a company’s ability to meet its interest obligations on debt. A strong ICR indicates that a property or company is financially stable, while a low ratio could signal potential financial distress. Whether you’re managing a business, investing or seeking funding for your next commercial property investment, understanding the ICR is key to making informed decisions.

What is the Interest Coverage Ratio?

The Interest Coverage Ratio measures how easily a company can pay the interest on its outstanding debt. It’s typically expressed as a multiple, representing how many times a company’s earnings can cover its interest payments.

For example:

• An ICR of 5x means the company earns five times the amount needed to pay its interest expenses.
• An ICR of 1x or below indicates the company might struggle or be unable to cover its interest payments.

This ratio is often used by:

• Lenders: To assess the risk of extending credit.
• Investors: To gauge the financial health and stability of a company.
• Business owners: To monitor their debt levels and ensure sustainable growth.

How to calculate the Interest Coverage Ratio (ICR)

The formula for the Interest Coverage Ratio is straightforward:

ICR = EBIT (Earnings Before Interest and Tax) / Interest Expense

EBIT: This is a company’s operating profit, excluding interest and taxes. It shows the profit generated purely from operations.

Interest expense: The total cost of interest a company pays on its outstanding debt over a specific period.

A step-by-step example

Let’s calculate the Interest Coverage Ratio for an investment property:

EBIT: $150,000 (rental income minus operating expenses)

Interest Expense: $50,000

ICR = $150,000/$50,000 = 3x

This means the property generates three times the income needed to cover its interest payments, which indicates moderate financial health.

What does your Interest Coverage Ratio mean?

Here’s how to interpret your ICR:

• Above 2.5: Healthy financial position; the company has no trouble covering its interest obligations.
• 1.5–2.5: Moderate financial risk; there’s enough profit to cover interest payments, but some caution is advised.
• Below 1.5: High risk; the company might struggle to meet its debt obligations and could face financial difficulties.

Calculate your Interest Coverage Ratio instantly

Want to save yourself the notepad space? Use our Interest Coverage Ratio Calculator below to determine your property’s ICR quickly. Simply input your EBIT and Interest Expense (find your EBIT here with our free EBIT calculator):

Why is your Interest Coverage Ratio important?

1. Risk management: Lenders and investors use this metric to assess the likelihood of default.
2. Decision-making: Property owners and companies monitor ICR to ensure sustainable debt levels for their current and future investments.
3. Investor confidence: A strong ratio can attract more investors or financing opportunities.

By understanding and monitoring your ICR, you can gain insight into your financial stability and make smarter financial decisions.