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Interest Cover Ratio measures a company’s operating profit (i.e. earnings before other income, interest, tax, depreciation and amortisation) relative to the amount of interest charges which the company pays. It indicates the extent to which earnings are available to meet the interest expenses. A Higher Interest Coverage Ratio indicates that the company can easily meet the interest expense pertaining to its debt obligations and vice versa.
A company’s earnings and operating profit fluctuates more than its interest expenses on a y-o-y basis, therefore it is advisable to look at previous year’s trends in Interest Coverage. In our view, Interest Coverage Ratio of below 1.5 should raise doubts about the company’s ability to meet the expenses on its borrowings. Interest Coverage Ratio below 1 indicates that the company is just not generating enough to service its debt obligations and that nothing is left for distribution amongst the shareholders.