What is EBITDA / Interest Expense?
When analysing the cash flow risk of a company, one of the ratio commonly used is the EBITDA/Interest Expense ratio. EBITDA is basically the Earnings Before Interest, Tax, Depreciation and Amortization of a company. The ratio is also known as the EBITDA-To-Interest Coverage Ratio. It can be used to measure a company’s ability to meet its interest expenses.
The formula for this ratio is:
EBITDA To Interest Coverage Ratio = EBITDA / Interest Payments
EBITDA Coverage Ratio is often compared with EBIT Coverage Ratio which formula is:
EBIT To Interest Coverage Ratio = EBIT / Interest Payments
However, EBITDA is typically seen as a better proxy for the operating cash flow of a company. When the ratio is equal to 1.0, it means that the company is generating only enough earnings to cover the interest payment of the company for 1 year. A low ratio indicates questionable cash flow issue in a company and it might not be of on-going concern while a high ratio is a sign of strong cash flows to cover its debt expenses.
For example, if a company has the following income statement:
Net income = $250,000
Interest expenses = $20,000
Income Tax = $10,000
Depreciation & Amortization = $50,000
The EBITDA Coverage Ratio = ($250,000 + $20,000 + $10,000 + $50,000) / $20,000 = 16.5
This means that the company has enough earnings to sustain 16.5 years of its interest expenses, if it stays stagnant.
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