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Company financial performance: Why Is interest coverage ratio Important?

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The Interest Coverage Ratio (ICR), also referred to as the Times Interest Earned (TIE) ratio, is a key financial metric used to assess a company's capacity to cover its interest expenses with its earnings. Interest Coverage Ratio (ICR) is one of the indicators to judge a company’s financial performance.
 


ICR: Key Insights


The Interest Coverage Ratio (ICR) measures a company's ability to fulfill its interest payments by comparing its Earnings Before Interest and Taxes (EBIT) to its interest expenses.

A higher ICR is generally seen as a sign of strong financial health, though ideal ratios can differ by industry. A ratio below 1.5 could signal potential financial strain.

Tracking ICR trends over time provides valuable insights into a company’s financial direction and short-term stability. While different stakeholders may have varying preferences for ICR levels, maintaining a healthy ratio is vital for long-term stability and growth, ensuring the company can meet its financial obligations.

There are various forms of the interest coverage ratio, including the EBIT Interest Coverage Ratio, EBITDA Interest Coverage Ratio, EBITDA Less CapEx, and Fixed Charge Coverage Ratio.
 


Why Is ICR Important?


The Interest Coverage Ratio (ICR) is a key financial metric that gauges a company's ability to meet its interest obligations on borrowed funds. A higher ICR signals that the company generates sufficient earnings to cover interest payments, which can make it more attractive to creditors. This, in turn, influences a company’s ability to secure additional financing or credit.

Conversely, a low ICR suggests the company may struggle to meet its debt obligations, potentially leading to difficulty in obtaining future credit and posing a risk to its financial stability. For shareholders and other stakeholders, a high ICR is a positive indicator, suggesting the company is well-positioned to handle its debt and reduce the risk of default. Maintaining a healthy ICR is vital for a company's long-term growth, as it ensures access to financing and supports smooth business operations without the constant threat of liquidity or solvency issues.
 


How to calculate interest coverage ratio?


Interest Coverage Ratio (ICR) is a financial metric used to assess a borrower’s ability to cover interest payments on outstanding debts. It is calculated by dividing the borrower’s total income (before interest and tax) by the total interest payments on their debts. For buy-to-let (BTL) landlords, brokers use ICR to determine whether rental income is sufficient to cover the mortgage interest on their properties. To do this, brokers compare the client’s annual rental income to the annual mortgage interest costs and monthly repayments.

Lenders typically require an ICR of at least 125%, meaning the landlord's rental income should be 25% higher than the interest payments. This ensures the borrower can comfortably manage interest expenses even if rental income fluctuates. Higher ICR thresholds may apply depending on the lender’s criteria, the property type, and other financial considerations, making it a key factor in determining loan eligibility for landlords.
 


Conclusion:


The Interest Coverage Ratio (ICR) is a crucial financial metric for assessing a borrower’s ability to meet interest payments on outstanding debts. It helps lenders gauge the risk associated with lending to a borrower, ensuring that they can comfortably service their debt obligations without straining their finances. For buy-to-let (BTL) landlords, the ICR is particularly important because it provides an indication of whether rental income is sufficient to cover mortgage interest, protecting both the landlord and lender from financial stress.

To calculate ICR, divide the borrower’s total income (before interest and tax) by the total interest payments on their debt. For landlords, this involves comparing annual rental income to annual mortgage interest costs. A higher ICR typically signals a lower risk, with a common threshold of 125% for BTL properties. Understanding and maintaining a healthy ICR is essential for securing and managing property loans effectively.
 



When considering shares, indices, forex (foreign exchange) and commodities for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. 

Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.

 

Written by
Frances Wang
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