Interest coverage, also called times interest earned, divides operating profit by the interest charge for the same period. A cover of 4 means the interest bill could be paid four times over from trading profit. Where debt to equity describes the size of the borrowing, interest cover describes whether it can actually be serviced, and lenders generally care far more about the second question than the first.
The usual numerator is EBIT, earnings before interest and tax, because interest is paid out of profit before tax is assessed. Many lenders prefer EBITDA, adding back depreciation and amortisation on the grounds that interest is paid in cash and those charges are not cash. Both are reported here: the EBITDA version is always the flattering one, and the gap between them is exactly the size of the non-cash charges.
Coverage also has a natural stress test built in. If interest is fixed, profit can fall by the reciprocal of the cover before the interest bill is no longer met. On the sample figures cover is 5.00, so operating profit could drop 80.0% before it reaches the interest charge exactly. Adding scheduled principal repayments gives the debt service coverage ratio, 2.82 here, which is the covenant most bank facilities are written around.
The formula
EBIT- Operating profit before interest and tax
Interest- Interest charged on borrowings in the period
D&A- Depreciation and amortisation added back for the EBITDA version
DSCR- (EBIT + D&A) ÷ (interest + scheduled principal repayments)
How to use this calculator
- Enter operating profit before interest and tax.
- Enter the interest charge for the same period.
- Add depreciation and amortisation for the cash-based version of the ratio.
- Add scheduled principal repayments to see the debt service coverage ratio.
Worked examples
$480,000 of operating profit against $96,000 of interest
Cover is 5.00 times on an EBIT basis. Adding $130,000 of depreciation and amortisation lifts it to 6.35 times, because those charges never leave the bank account. Interest consumes 20.0% of operating profit.
Adding principal to the test
With $120,000 of scheduled repayments the annual debt service is $216,000, so the coverage ratio falls to 2.82 times. A facility written at a 1.25 minimum would leave headroom of $340,000 of cash profit before breach.
How to read your score
Frequently asked questions
Should I use EBIT or EBITDA for interest cover?
EBIT is the textbook definition and the more conservative one. EBITDA cover is common in loan documents because interest is paid in cash while depreciation is not. Quote which you used, because the two can differ by a wide margin in asset-heavy businesses.
What cover do lenders usually require?
Two to three times as an absolute floor, with three to four preferred for a trading company. Facilities normally also set a debt service cover minimum around 1.20 to 1.30, which includes principal repayments.
What does the profit cushion figure mean?
It is how far operating profit could fall before it exactly equals the interest bill, assuming interest is fixed. At 4 times cover the cushion is 75%; at 1.5 times it is only 33%.
How does a rate rise affect this?
On floating-rate debt, cover falls in proportion to the rate. Doubling the interest rate halves the cover, which is why coverage tests bite quickly when rates move and margins are thin.
Coverage reference
| Operating profit | interest $40k | interest $60k | interest $96k | interest $150k | interest $250k |
|---|---|---|---|---|---|
| EBIT $150k | 3.75 | 2.50 | 1.56 | 1.00 | 0.60 |
| EBIT $300k | 7.50 | 5.00 | 3.12 | 2.00 | 1.20 |
| EBIT $480k | 12.00 | 8.00 | 5.00 | 3.20 | 1.92 |
| EBIT $750k | 18.75 | 12.50 | 7.81 | 5.00 | 3.00 |
| EBIT $1200k | 30.00 | 20.00 | 12.50 | 8.00 | 4.80 |
EBIT basis. Adding back depreciation raises every cell.
| Interest cover | Interest as a share of EBIT | Profit fall tolerated | Rate rise tolerated |
|---|---|---|---|
| 1.2× | 83.3% | 16.7% | 20% |
| 1.5× | 66.7% | 33.3% | 50% |
| 2.0× | 50.0% | 50.0% | 100% |
| 3.0× | 33.3% | 66.7% | 200% |
| 4.0× | 25.0% | 75.0% | 300% |
| 6.0× | 16.7% | 83.3% | 500% |
| 10.0× | 10.0% | 90.0% | 900% |
The last column is how far a floating interest rate could rise, on unchanged profit, before cover reaches 1.0.