Interest Coverage Ratio

The interest coverage ratio is used in conjunction with the debt ratio to evaluate the ability of earnings to service the interest component of debt payments. It is calculated by dividing earnings before interest, taxes, depreciation and amortization (EBITDA) by the total interest paid.

Leverage Ratios

Financial Leverage

Leverage refers to the ability to lift a heavier load using a fulcrum and a lever. The common image is a board on a triangular pivot point with a heavy weight (M1) on one end and a lighter weight (M2) on the other. As the lever shifts towards the lighter load it starts to lift the heavier weight. In effect, as the distance ‘b’ gets longer, it becomes easier to lift M1. This principle works with finances too.  How so?

Interest Coverage Ratio

The last of the leverage ratios isn’t really a pure leverage indicator but augments the debt ratio. Debt requires the payment of interest and so an indicator of the ability to pay this interest is needed. This is the interest coverage ratio.

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