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Interest Coverage Ratio

A bank is about to lend money to a company. It needs one quick number to judge the risk. That number is often the Interest Coverage Ratio. It tells a lender how easily a borrower can pay the interest it already owes, before a single new rupee changes hands.

BSE building at Dalal Street, Mumbai
The Bombay Stock Exchange building on Dalal Street, Mumbai. Listed firms disclose the earnings and interest costs that go into their Interest Coverage Ratio. Photo by BSEINDIA, CC BY-SA 3.0, via Wikimedia Commons.
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EBIT ÷ Interest Expense
The Interest Coverage Ratio formula — how many times over a firm’s earnings can pay its interest bill.
Comfortable
ICR > 1.5
Earnings cover interest with room to spare
Red Flag
ICR < 1
Earnings cannot cover the interest bill
Used By
Banks & Lenders
Assessed before extending or renewing a loan
Tracked By
RBI FSR
Aggregate ICR watched as a stress indicator
The core idea: a higher ICR means a firm’s earnings comfortably cover its interest bill. A falling ICR is an early warning sign, even before an actual default.
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📑 Contents
✊ Must Know
1. What the ratio measures
  • Concept The Interest Coverage Ratio (ICR) measures how easily a firm can pay the interest on its outstanding debt from its earnings.
2. The formula
  • Formula ICR is calculated as Earnings Before Interest and Tax (EBIT), divided by the total interest expense for the period.
3. Higher is safer
  • Fact A higher ICR means a firm’s earnings comfortably cover its interest bill. This signals lower default risk to a lender.
4. Why banks check it
  • Use Banks use ICR to assess both the present and the emerging risk of a firm before extending or renewing a loan.
5. A falling ICR is a warning sign
  • Fact A steadily falling ICR warns that a firm’s earnings are weakening relative to its debt burden, even before it actually defaults.
📘 Good to Know
1. A common risk threshold
  • Fact Lenders and credit-rating agencies often treat an ICR below 1.5 as a red flag, and below 1 as a sign the firm cannot cover interest from operating earnings.
2. ICR versus Debt Service Coverage Ratio
  • Concept The Debt Service Coverage Ratio is broader than ICR. It covers both interest and scheduled principal repayment, not interest alone.
3. Watched closely in cyclical sectors
  • Fact Capital-heavy, cyclical sectors like telecom, power, and infrastructure draw extra ICR scrutiny, since their earnings swing sharply across business cycles.
4. Linked to loan classification
  • Fact A sustained weak ICR is one input banks use when flagging a loan account under RBI’s early-warning stressed-asset categories.
5. Reported in company filings
  • Fact Listed Indian companies routinely report ICR in their annual reports and credit-rating disclosures, since exchanges and lenders both track it.

Test Yourself

1. Which of the following statements about the Interest Coverage Ratio (ICR) is correct?

 

🏆 Great to Know
1. The 2015-16 twin balance sheet crisis
  • History During India’s twin balance sheet crisis, RBI data showed a large share of debt held by companies with an ICR below 1.
2. Tracked in the Financial Stability Report
  • Fact RBI’s Financial Stability Report regularly publishes the aggregate ICR of listed non-financial companies, as a gauge of corporate sector health.
3. A link to insolvency proceedings
  • Analysis A firm with a persistently low ICR often ends up referred under the Insolvency and Bankruptcy Code, once it actually misses interest payments.
4. A global, not just Indian, metric
  • Context ICR is a standard credit-analysis metric used by lenders and rating agencies worldwide, not a concept unique to India.
5. Its main limitation
  • Limitation ICR uses accounting earnings (EBIT), not actual cash flow. A firm can show a healthy ICR while still facing a real cash crunch.
📝 Previous Year Questions
UPSC CSP 2020, GS Paper I, Q62: Interest Coverage Ratio
  • Prelims PYQ Asked what the Interest Coverage Ratio tells a bank about a borrowing firm’s present and emerging risk.
  • View this question →
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