Financial Statement Analysis

- Ratio Analysis of Financial Statements (Formula, Types, Excel)
- Ratio Analysis Advantages
- Ratio Analysis
- Liquidity Ratios
- Cash Ratio
- Cash Ratio Formula
- Quick Ratio
- Quick Ratio Formula
- Current Ratio
- Current Ratio Formula
- Acid Test Ratio Formula
- Defensive Interval Ratio
- Working Capital Ratio
- Working Capital Formula
- Net Working Capital Formula
- Changes in Net Working Capital
- Cash Flow from Operations Ratio
- Cash Reserve Ratio
- Operating Cycle Formula
- Current Ratio vs Quick Ratio
- Bid Ask Spread
- Liquidity vs Solvency
- Liquidity
- Solvency
- Solvency Ratios
- Equity Ratio
- Capital Adequacy Ratio
- Liquidity Risk
- Altman Z Score

- Turnover Ratios
- Inventory Turnover Ratio
- Accounts Receivable Turnover
- Accounts Receivables Turnover Ratio
- Accounts Payable Turnover Ratio
- Days Inventory Outstanding
- Days in Inventory
- Days Sales Outstanding
- Average Collection Period
- Days Payable Outstanding
- Cash Conversion Cycle
- Cash Conversion Cycle (CCC) Formula
- Fixed Asset Turnover Ratio Formula
- Debtor Days Formula
- Working Capital Turnover Ratio

- Profitability Ratios
- Profitability Ratios Formula
- Common Size Income Statement
- Vertical Analysis of Income Statement
- Profit Margin
- Gross Profit Margin Formula
- Gross Profit Percentage
- Operating Profit Margin Formula
- EBIT Margin Formula
- Operating Income Formula
- Net Profit Margin Formula
- EBIDTA Margin
- Degree of Operating Leverage Formula (DOL)
- NOPAT Formula
- OIBDA
- Earnings Per Share
- Basic EPS
- Diluted EPS
- Basic EPS vs Diluted EPS
- Return on Equity (ROE)
- Return on Capital Employed (ROCE)
- Return on Invested Capital (ROIC)
- Return on Sales
- ROIC Formula (Return on Invested Capital)
- Return on Investment Formula (ROI)
- ROIC vs ROCE
- ROE vs ROA
- CFROI
- Cash on Cash Return
- Return on Total Assets (ROA)
- Return on Average Capital Employed
- Capital employed Employed
- Return on Average Assets (ROAA)
- Return on Average Equity (ROAE)
- Return on Assets Formula
- Return on Equity Formula
- DuPont Formula
- Net Interest Margin Formula
- Earnings Per Share Formula
- Diluted EPS Formula
- Contribution Margin Formula
- Unit Contribution Margin
- Revenue Per Employee Ratio
- Operating Leverage
- EBIT vs EBITDA
- EBITDAR
- Capital Gains Yield
- Tax Equivalent Yield
- LTM Revenue
- Operating Expense Ratio Formula
- Overhead Ratio Formula
- Variable Costing Formula
- Capitalization Rate
- Cap Rate Formula
- Comparative Income Statement
- Capacity Utilization Rate Formula
- Total Expense Ratio Formula

- Efficiency Ratios
- Dividend Ratios
- Debt Ratios
- Debt to Equity Ratio
- Debt Coverage Ratio
- Debt Ratio
- Debt to Asset Ratio Formula
- Coverage Ratio
- Coverage Ratio Formula
- Debt to Income Ratio Formula (DTI)
- Capital Gearing Ratio
- Capitalization Ratio
- Interest Coverage Ratio
- Times Interest Earned Ratio
- Debt Service Coverage Ratio (DSCR)
- DSCR Formula (Debt service coverage ratio)
- Financial Leverage Ratio
- Financial Leverage Formula
- Degree of Financial Leverage Formula
- Net Debt Formula
- Leverage Ratios
- Leverage Ratios Formula
- Operating Leverage vs Financial Leverage
- Current Yield
- Debt Yield Ratio
- Solvency Ratio Formula

## What is Coverage Ratio Formula?

Coverage Ratios are used to analyze a company’s ability to meet obligations. Obligations are in the form of debt payments, debt interest payments or lease payments. Some of the popular coverage ratios formulas are debt coverage ratios, interest coverage ratios and fixed charge coverage ratio.

The formulas for these three popular Coverage Ratios are as follows:

**#1 – The Fixed Charge Coverage Ratio**

**Fixed Charge Coverage Ratio Formula = (EBIT+ Lease payments)/ (Interest payments+ Lease payments)**

**#2 – Interest coverage ratio**

**Interest Coverage Ratio Formula = EBIT/ Interest payments**

**#3 – Debt coverage ratio**

**Debt Coverage Ratio Formula= Cash Flow From Operations/ Total Debt**

### Explanation of Coverage Ratios Formula

Coverage ratios formula is used to determine how much a company earns operating profit or cash from operations in order to cover its liabilities in the form of interests or lease payments. Interest expense is a liability for the company which the company needs to pay to its lenders, who lend the company money in order to expand the business. Most part of the interest expense is due to long term debt of the company that why this ratio is also considered as the solvency ratio as it signifies whether the company is solvent enough to pay the debt.

If the company is not able to generate enough operating profit to pay off the interest then the debt holders can ask the company to file for bankruptcy and sell their assets in order to pay the debt to the debt holders. Creditors look for higher ratio which signifies that the company is covering the interest payment with its operating income generated through the normal course of the business. The coverage ratios are not represented in the form of a percentage; it is represented in the form of an absolute number in order to find out by how many time the operating profit covering the interest cost.

**Examples of Coverage Ratio Formula (with Excel Template)**

Let’s see some simple to advanced examples of coverage ratio formula to understand it better.

#### Example #1

**Let us try to understand how to calculate these three ratios with the help of an arbitrary Company A. We need to make some assumptions in order to calculate these ratios.**

Let us assume that the EBIT (earnings before interest and taxes) for company A are $400 million. And the company has taken some assets which are part of their balance sheet in a lease and did not buy the asset outright. Let’s assume that the lease payments for those assets combined for a quarter are $45 million. And the company has taken debt to buy assets. Let’s assume that the interest payments for that debt combined for a quarter is $50 million and cash flow from operations which is also known as CFO for company A is $3000 million. And the company has taken debt to buy assets. Let’s assume that the total debt taken by a company is $700 million.

Use the following information for the calculation of the coverage ratios formula.

4.8 (388 ratings)

**#1 – Fixed Charge Coverage Ratio Formula**

Fixed Charge Coverage Ratio Formula = ($400 + $45) / ($50 + $45)

=4.68

So the fixed charge coverage ratio for the company will be 4.68. Higher the ratio better it is as it signifies that the company is able to cover the liabilities almost 5 times over with the help of its operating profits.

**#2 – Interest Coverage Ratio Formula**

Interest Coverage Ratio Formula = $400 / $50

=8.0

So the interest coverage ratio for the company will be 8. Higher the ratio better it is as it signifies that the company is able to cover the liabilities almost 8 times over with the help of its operating profits.

**#3 – Debt Coverage Ratio Formula **

Debt coverage ratio Formula = $3,000 / $700

=4.29

So the debt coverage ratio for the company will be 4.29. Higher the ratio better it is as it signifies that the company is able to cover the debts with the cash generated from operations.

#### Example #2

**The operating profit or EBIT for industries for a quarter is Rs 17341 crore. And the interest expense or finance cost for the period is Rs 4,119 crore. We can calculate the interest coverage ratio formula for reliance for the quarter using these two numbers.**

Use the following information for the calculation of the interest coverage ratio formula.

Therefore, the calculation of the interest coverage ratio is as follows,

- Interest Coverage Ratio = 17341 / 4110

** Interest Coverage Ratio will be –**

The interest coverage ratio= 4.21

This signifies that the company is able to generate operating profit which is four times over the total interest liability for the period.

#### Example #3

**The operating profit or EBIT for industries for a quarter is Rs 5800 crore. And the net interest expense or finance cost for the period is Rs 1116 crore. We can calculate the interest coverage ratio for reliance for the quarter using these two numbers.**

Use the following information for the calculation of the interest coverage ratio.

Therefore, the calculation of the interest coverage ratio is as follows,

The interest coverage ratio= 5800/1116

**Interest Coverage Ratio will be –**

Interest Coverage Ratio = 5.20

This signifies that the company is able to generate operating profit which is five times over the total interest liability for the period.

### Relevance and Uses

Coverage ratios formula is one of the most important formulas for the creditors in order to find out the credit health of a company. It shows how many times the operating profit of a company from its business operations is able to cover the total interest expense for the company in a given period of time. Creditors or investors of a company look for this ratio whether the ratio is high enough for the company. Higher the ratio better it is from the perspective of the lenders or the investors.

A lower ratio will signify both liquidity issues for the firm and also in some cases it may also lead to solvency issues for a company. If the company does not earn enough operating income from the normal courses of the business, then it will not be able to repay the interest of the debt.

### Recommended Articles

This has been a guide to Coverage Ratios Formula. Here we discuss how to calculate Coverage Ratios along with the practical examples and downloadable excel sheet. You can learn more about accounting from the following articles –

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