GETTING SMARTER SERIES

Interest Coverage Ratio

What is Interest Coverage Ratio (ICR)

 It is a financial ratio that measures a company’s ability to make interest payments on its
debt in a timely manner

Earnings Before Interest and Taxes

Interest Coverage Ratio Interest Expense

 Measures how many times a company could pay its current interest payment with its
available earnings

 This ratio can be thought of as a margin of safety for the company’s creditors should the
company run into financial difficulty down the road

 Analyzing the ICR over time provides a better picture of whether or not the debt is
becoming a burden on the company’s financial position

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Variation of Interest Coverage Ratio (ICR)

 There are few variations in the ICR which come from alterations to EBIT in the
numerator of the ICR calculations:

 Calculating ICR using earnings before interest, taxes, depreciation and

amortization (EBITDA) instead of EBIT.

 Depreciation & amortization expense are non cash expense and may not be
relevant in assessing ICR.
 Since the interest expense will be same in both cases, calculations using
EBITDA will produce a higher ICR than calculations using EBIT.

 Calculating ICR using earnings before interest after taxes (EBIAT) instead of EBIT.

• Because taxes are an important financial element to consider, for a clearer

picture of a company’s ability to cover its interest expenses one might use
EBIAT in calculating ICR instead of EBIT

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Illustration - Understanding interpretation of ICR for a Company

 Mr. Anuj Sharma owns Chic-Choc Company Ltd* which is a chocolate manufacturing
company. He is planning to expand his business operations and requires funds for
purchasing new machinery.

 He goes to several banks with his financial statements to try to get the funding.
Chic-Choc Company Ltd

EBIT : Rs. 1,000,000

Interest Expenses : Rs. 3,03,000

 With the above financials of Chic-Choc Company Ltd, its ICR will work out to be:
Chic-Choc Company Ltd

Interest Coverage Ratio: = 1,000,000/3,03,000 3.30

 This means that Chic-Choc Company makes 3.30 times more earnings than the current
interest payments. It can well afford to pay the interest on the current debt along with its
principal payments.

Disclaimer: In this material DSP Investment Managers Pvt. Ltd. (the AMC) has used information that is publicly available, including information developed in-house. Information gathered
and used in this material is believed to be from reliable sources. The AMC however does not warrant the accuracy, reasonableness and / or completeness of any information. The above
data/statistic are given only for illustration purpose. The recipient(s) before acting on any information herein should make his/their own investigation and seek appropriate professional
advice. This is a generic update; it shall not constitute any offer to sell or solicitation of an offer to buy units of any of the Schemes of the DSP Mutual Fund.

Mutual Fund investments are subject to market risks, read all scheme related documents carefully. 4