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?

Coverage Ratios are the financial ratios which are used to determine whether the firm can pay off its debt obligation. If this ratio is on the higher side, that means the firm is a healthier position to return its debt. Usually, It is used to compare a firm’s capability against similar companies or comparing the trend against previous years.

### Top 4 Types of Coverage Ratio with Formula

Analysts use below-mentioned coverage ratios to determine the firm’s position for its debt obligations:

#### #1 – Interest Coverage Ratio

It is used to determine how well a company can pay off its interest in debt using its earnings. It is also known as Times Interest Earn Ratio.

##### Interest Coverage Ratio Formula

Interest Coverage Ratio Formula = EBIT / Internet Expense

#### #2 – Debt Service Coverage Ratio

This ratio determines the company’s position to pay off its entire debt from its earnings. Company’s ability to repay the entire principal plus interest obligation of debt in the near term is measured by this ratio. If this ratio is more than 1 than the company is in a comfortable position to repay the loan.

##### Debt Service Coverage Ratio Formula

Debt Service Coverage Ratio Formula = Operating Income / Total Debt

#### #3 – Asset Coverage Ratio

This ratio is similar to the Debt Service ratio, but instead of Operating Income, it will see whether debt can be paid off from its assets. If the firm is not able to generate enough income to repay debt, then whether the assets of the company such as land, machinery, inventory etc. can be sold off to give back the loan amount. Usually, this ratio should be more than 2.

##### Asset Coverage Ratio Formula

Asset Coverage Ratio Formula = (Tangible Asset – Short TermLiabilities)/Total DebtOperating Income / Total Debt

#### #4 – Cash Coverage Ratio

Cash Coverage is used to determine whether a firm can pay off its interest expense from available cash. It is similar to the Interest Coverage, but instead of Income, this ratio will analyze how much cash available to the firm. Ideally, this ratio should be greater than 1.

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##### Cash Coverage Ratio Formula

Cash Coverage Ratio Formula = (EBIT + Non Cash Expense)/Interest Expense

### Examples of Coverage Ratios

Below we have taken the basic and practical examples of Coverage Ratios.

#### Coverage Ratio Example #1

**Let’s say a firm’s total “Operating Income” (EBIT) for the given period is $1,000,000 and its total outstanding principal debt is $700,000. The firm is paying 6% interest on the debt**.

So, its total interest expense for giving period =debt * interest rate

=700,000*6% = $42,000

**Debt Service Coverage**

total debt payable (Principal plus interest)

**Asset Coverage**

Let’s say the firm is having $900,000 of tangible assets and its short-term liabilities are $100,000

**Cash Coverage**

And non-cash expenses are $100,000

By analyzing these ratios, it can be said that for now, the firm is in a comfortable position to pay off its debt using its earning or asset.

#### Coverage Ratio Example #2

**Let’s take a practical example of an Indian company which is having quite a high amount of debt in its balance sheet. Bharti Airtel is an Indian telecom company which is known as a very high debt-ridden company because of high CapEx requirement in this industry**

Below are some of the basic data for Bharti Airtel:

Data in Rs Mil.

*Source: Annual Reports and **www.moneycontrol.com*

In the below graph we can analyze the trend of coverage ratios for Bharti Airtel:

As we can see that over the years these ratios are going down. It is because of its debt has increased over the years and EBIT has gone down because of margin pressure and entry of “Reliance Jio” into the market. If this continues in the future, then Bharti Airtel could be in a bad position regarding its debt or maybe it has to sell off its assets to repay the loan.

### Advantages of Coverage Ratios

- It can be used to do trend analysis for a company over the period. By calculating ratios over the period of times it can be analyzed that how its debt repaying ability is moving over the periods. If it is going down, then the firm will have to look down into issue and try to correct that.
- These ratios can be used by lenders/ creditors before giving a loan. Whether the firm is worthy of loans and at what interest rate loan should be provided.
- Analysts use these ratios to determine the credit rating of the firm. If the ratings are good, then firms get a loan at lower interest rates.

### Limitations of Coverage Ratios

- There may be the case that for a given period a firm has taken more debt, but its effect will come into the next periods. Also, seasonality can be a factor which hides or distort these ratios.
- Some companies are having higher CapEx requirements, so their debt size will be more than other companies.
- That can be cases when companies change their accounting policies and because of that, these ratios can be affected.
- We should not use these ratios as stand alone. While checking firm health, other ratios such as liquidity or profitability ratios also need to be analyzed alongside to make the decision.

### Conclusion

It is quite useful in checking the credit rating of a firm or to analyze at what rate, the loan should be given to the firm. But it needs to be used quite carefully keeping other factors in mind. Some companies require more debt compared to other companies so maybe their ratios are on the weaker side. There may be cases when a firm is trying to expand so it has taken a loan for capital expenditures which will give result after maybe 2 or 3 years. So, at present, its ratio may not be good. Just remember, ratios are helpful for analysis until these are analyzed keeping all factors in mind and not just by seeing the numbers as standalone.

### Recommended Articles

This has been a guide to what is Coverage Ratio?. Here we discuss the top 4 types of Coverage Ratio including interest coverage, debt service coverage, cash coverage and asset coverage along with practical examples. You can learn more about from the following articles –

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