Interest coverage ratio

A ratio compares two figures to reveal something neither number shows on its own. The interest coverage ratio compares the profit a company generates from operations against the interest it owes, showing how comfortably it can service its debt.

The interest coverage ratio divides operating income by interest expense. It shows how many times over a company could pay its interest obligations out of the profit it generates from running the business, before touching anything else.

The formula is:

A high interest coverage ratio means a company generates far more operating profit than it needs to cover its interest payments, leaving a comfortable buffer even if earnings decline. A low interest coverage ratio means interest payments are consuming a large share of operating profit, leaving little room for earnings to fall before the company struggles to meet its obligations, a warning sign of financial fragility.

Interest coverage is most useful alongside the debt-to-equity ratio. A company can carry a large amount of debt and still be financially healthy if its earnings comfortably cover the interest, while a company with modest debt but weak or volatile earnings can still be at risk if its interest coverage is thin.