Which ratios measure the firms ability to meet its interest

Which ratio(s) measure the firm’s ability to meet its interest costs?

Solution

Interest coverage ratio measures the firm’s ability to meet the interest expenses in times.

Formula for interest coverage ratio:

Interest coverage ratio = Earnings Before Interest and Tax (EBIT) / Interest Expense

Higher the ratio better the ability of firm to pay its interest costs.

The earning before interest and tax or EBIT, is taken in numerator for formula because interest is paid before income taxe and if a firm has high EBIT then it can pay more interest towards its borrowing or we can say firm can take more borrowings for which it has sufficient EBIT.