Plain definition
Interest coverage ratio compares earnings available before interest and tax (EBIT) with the interest expense for the same period. It asks how many times the stated earnings measure covers the stated financing charge. A lender may define both figures differently from the published accounts, for example in its treatment of lease interest or permitted adjustments.
Illustrative example
Monetary examples use Saudi riyals (SAR). The same principles apply in other currencies.
A company has EBIT of and interest expense of , so coverage is 3.0 times. It is considering a loan that would add annual interest. If EBIT stayed unchanged, coverage would fall to 2.0 times.
The finance director compares 2.0 times with the agreement’s minimum before committing. If the covenant requires at least 2.25 times, the extra loan creates a breach even though the company remains profitable. She can reduce borrowing, improve recurring earnings, or seek lender consent before drawing it.
Interest coverage is an earnings test. It does not prove the company has cash on each interest-payment date.
Why it matters
A profitable company can fail an interest covenant after a small fall in EBIT or rise in financing cost. Looking only at total debt misses this sensitivity and can leave management negotiating after a breach rather than before it.
Practical consequence
Copy the contract’s EBIT, interest, adjustment, and test-date definitions into a covenant schedule. Recalculate the ratio for lower earnings, higher rates, and planned borrowing; then compare the results with the dated cash forecast for actual interest dates. Escalate before the internal warning level, not only at the contractual minimum.