Interest coverage ratio (ICR), also referred to as times interest earned ratio, is a financial ratio that measures the ability of a company to meet its interest payments on outstanding debts. It is a commonly used metric by lenders, creditors, and investors to assess the riskiness of lending capital to a business.
The formula for calculating the interest coverage ratio is as follows:
Interest Coverage Ratio = Earnings Before Interest and Taxes (EBIT) / Interest Expense
To interpret the ICR, a low ratio (ICR < 1) could indicate a higher risk associated with the company because its operating profit might be insufficient to cover the interest payments and therefore a higher chance of bankruptcy. A high ICR could mean that a company is overlooking opportunities to increase profitability through leverage. Generally speaking, an ICR above 2 or 3 is optimal for a company.