Interest Coverage Ratio

Meaning

ICR is the debt & profitability ratio used to determine how easily a firm can pay or cover the interest on its outstanding debt.

• banks & companies are interdependent
  • $\to$ loans given by banks necessary for growth of company
• however, loans are high risk $\leftarrow$ can increase NPA
  • $\therefore$ FI (eg banks) check availability of firms to repay debt before sanctioning loans
• banks use different parameters to distinguish good firms from weak
  • one such parameter is ICR

$$ICR=\frac{\text{Profits}}{\text{Interest to be paid}}$$

eg. if

• company’s earnings before taxes and interest $=$ 100
• total interest payment requirement $=$ 50

$$\begin{array}{rl}ICR& =\frac{\text{Profits}}{\text{Interest to be paid}}\\ ⟹ICR& =\frac{100}{50}\\ ⟹ICR& =2\end{array}$$

• no universally accepted optimal ICR
  • atleast 2 is generally proferred
  • highly productive company can have ICR of 10
  • if company has low ICR $⟹$ high change it will not be able to service its debt
    • puts firm at risk of insolvency

see also:

• Insolvency and Bankruptcy Code