Fixed Charge Coverage Ratio Analysis

Tags: analysis, EBIT, fixed charge coverage ratio, lease
By: Dan
July 23, 2013

Fixed Charge Coverage Ratio Analysis Formula

See the fixed charge coverage ratio analysis formula below:

Times Interest Earned Ratio = (EBIT + fixed charge) ÷ (total interest + fixed charge)

Fixed Charge Coverage Ratio Calculations

Fixed charge coverage ratio calculations can be simple or difficult depending on the complexity of the associated financial information. For example, a company has $ 16,000 in EBIT, $ 1,000 in interest payments and $2,000 in lease payments.

Fixed charge coverage ratio = (16,000 + 2,000) / (1,000 +2,000) = 8

This means that a company has earned eight times its fixed charges.

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Fixed Charge Coverage Ratio Example

For example, Ron owns a small business which provides artisan-quality roofing services to upscale homes. Ron has carved a unique niche for his company over time. He is proud of his achievements and satisfied customer base.
Recently, the recession has caused Ron to see less jobs for Spanish tile roofing. With this serving as the bread-and-butter of Ron’s company, he wants to be prepared for additional dips in his revenues due to less sales.
Ron, essentially, wants to perform fixed charge coverage ratio analysis to assure that his company can survive the recession.
Ron speaks to his controller and performs the following equation. Ron’s company has $ 16,000 in EBIT, $ 1,000 in interest payments and $2,000 in lease payment. So…

Fixed charge coverage ratio = (16,000 + 2,000) / (1,000 +2,000) = 8

After speaking with his controller, Ron is confident that his company can survive an extended recession. He needs to check he has not violated his fixed charge coverage ratio covenant (bank requirement) for his bank loan.
Ron’s company controller looks at the agreement. Ron, after a little work, realizes that his company has not violated a covenant. Despite the fact that Ron’s company has an acceptable fixed charge coverage ratio, EBITDA will remain the same for his covenants with the bank to stay unbroken. Ron respects the value of keeping up-to-date with financial statements, as well as bank agreements, thanks to the hand of his company accountant.