Fixed-Charge Coverage Ratio
AdvancedThe fixed-charge coverage ratio measures a company's ability to pay its fixed financing charges, such as interest and lease payments, out of its earnings.
The interest coverage ratio looks only at interest. The fixed-charge coverage ratio is broader, including other fixed obligations that must be paid regardless of performance, most commonly lease payments.
A common version adds fixed charges back to earnings before interest and tax, then divides by the total of interest and fixed charges. For example, a company with EBIT of 900,000, lease payments of 300,000 and interest of 200,000 has a fixed-charge coverage ratio of 1,200,000 divided by 500,000, or 2.4. Its earnings cover its fixed charges 2.4 times.
Lenders use this ratio to judge credit risk, especially for businesses with large lease commitments, such as retailers, restaurant chains and airlines. Loan agreements often require it to stay above a minimum level.
Definitions vary between lenders and analysts. Some include preferred dividends or required debt repayments, and some use EBITDA. Comparisons should use the same definition.
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