Debt Coverage Ratio Definition

Forex Glossary

Definition

The word debt coverage ratio identifies some step which makes it possible for the investor-analyst to grasp the means of a business to satisfy its long term debt duties. Your debt coverage ratio is seen by accepting managing earnings and separating it by interest expenditure and chief payments coming due within exactly the exact same period.

Calculation

Debt Coverage Ratio = Operating Income / (Interest Expense Principal Payments / (1- Tax Rate))

Where:

  • Operating income is got from the business ‘s income statement and can be equal to earnings before taxes and interest (EBIT).
  • The denominator of the ratio comprises the interest and principal payments adjusted for taxation.

Explanation

Capital structure and solvency measures allow the investor-analyst to grasp the provider ‘s power to stay in operation while in the long run. That is generally evaluated by examining the association between equity, debt and also the proportions of several sorts of stock. Solvency is your ability to keep on operating, which often times depends upon cashflow. One of those techniques to comprehend the total solvency position of a provider is by simply calculating their debt coverage ratio.

The debt coverage ratio stipulates that the investor-analyst with advice concerning the skill of an organization to settle debt. This metric compares earnings before taxes and interest (EBIT) to the interest rate paid by the provider as well as any scheduled principal obligations coming due on precisely the exact same period. In the event the provider is generating enough money to generate its own debt obligations, then this ratio is likely to be 1.0 or more.

Example

Company ABC’s CFO would like to be certain the organizations earnings are adequate to pay for its own debt obligations before releasing financing of employee’s incentive compensation for that season. She asked her analytic team to figure the organizations debt coverage ratio with their own year end prediction. The info located on the prediction included operating earnings of 1,287,000,000, interest expense of $592,000,000, and primary obligations coming because of $296,000,000. The Business ‘s debt coverage ratio could subsequently be:

= 1,287,000,000 / ($592,000,000 ($296,000,000 / (1 – 0.21))
= 1,287,000,000 / ($592,000,000 $374,684,000)
= 1,287,000,000 / ($592,000,000 $374,684,000)
= 1,287,000,000 / $966,684,000, or 1.33

Since your debt coverage ratio has been more than 1.0, the CFO approved financing of the worker incentive reimbursement program.