What is Interest Coverage Ratio?
The interest coverage ratio, also called Times Interest Earned, measures how easily a company can pay interest on its outstanding debt from its operating earnings. It is computed as EBIT divided by interest expense. A higher ratio indicates a larger margin of safety; a ratio below 1.5x is generally considered weak by credit analysts.
How It Works
- Compute EBIT (earnings before interest and tax) from the income statement.
- Identify gross interest expense for the period.
- Interest Coverage = EBIT / Interest Expense.
- Variants use EBITDA or EBITDAR for interest plus rent obligations.
- Compare against lender covenants (typically 2.0x to 3.0x minimum).
Saudi Context
Saudi banks and bondholders use interest coverage as a core covenant in term loans, sukuk indentures, and Saudi Industrial Development Fund (SIDF) financing. SIDF often requires coverage above 2.0x. CMA-listed companies disclose interest coverage trends in MD&A. Banks operate higher leverage and use other coverage metrics specific to financial institutions.
Example
A manufacturer’s EBIT is SAR 18 million and interest expense SAR 4 million. Interest coverage = 18 / 4 = 4.5x. Operating earnings cover interest payments 4.5 times, comfortably above the lender’s 2.5x covenant.