What is the interest coverage ratio? How does it affect capital structure? Illustrate the effect of interest coverage ratio on capital structure with suitable example.
What is the interest coverage ratio? How does it affect capital structure? Illustrate the effect of interest coverage ratio on capital structure with suitable example.
Interest Coverage Ratio (ICR) determines whether a business can pay interest on out-standing debt. It is calculated by dividing the company's earnings before interest and taxes (EBIT) for a particular time period by comany's interest expenses.
Formula : ICR=EBITInterest Expense
Suppose, a bakery business' earnings before interest and taxes is Rs 50,000 and the interest expenses are Rs 15,000.
The ICR=5000015000=3.33 which means that the bakery makes 3.33 times more earnings that the current interest payments. If the nterest expense were to increase by Rs 20,000 then the ICR would be 2.5. This means that a low ICR would sugges that the company is not making sufficient revenues to cater to interest expenses of the business.
Interest Coverage Ratio (ICR) determines whether a business can pay interest on out-standing debt. It is calculated by dividing the company's earnings before interest and taxes (EBIT) for a particular time period by comany's interest expenses.
Formula : ICR=EBITInterest Expense
Suppose, a bakery business' earnings before interest and taxes is Rs 50,000 and the interest expenses are Rs 15,000.
The ICR=5000015000=3.33 which means that the bakery makes 3.33 times more earnings that the current interest payments. If the nterest expense were to increase by Rs 20,000 then the ICR would be 2.5. This means that a low ICR would sugges that the company is not making sufficient revenues to cater to interest expenses of the business.
