Interest coverage
Earnings before interest and tax over interest expense. It relates the obligation to the earnings that must meet it, which a balance sheet ratio cannot.
Where you will meet it
Interest coverage appears in 7 learning outcomes on the CFA syllabus. A few of them:
- Work out liquidity, solvency and activity ratios and explain what they mean
“Solvency ratios ask about the longer term, with debt-to-equity and interest coverage.”
- Analyse and explain the effect of balance sheet adjustments, normalised earnings and cash flow statement adjustments on a company's financial statements, ratios and overall financial condition
“Adjusted ratios such as debt to EBITDA and interest coverage then feed credit and valuation judgements.”
- Contrast the approaches for estimating what debt costs a firm
“Where the issuer is unrated, a synthetic rating assigns a rating from ratios such as interest coverage, then adds the matching spread to a government yield.”
- Explain issuer-level (bottom-up) ways of running a credit strategy
“They first split the universe into sectors so that like is compared with like, then assess each issuer's credit quality (leverage, interest coverage, cash flow, business risk, covenants) against its spread.”
Practise it
Practise interest coverage until it is automatic: questions that explain every wrong option.
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