EBITDA-to-Interest Coverage Ratio: What it Is and How to Use It
The EBITDA-to-interest coverage ratio measures a company’s ability to meet interest payments from its operating cash earnings. It uses EBITDA (earnings before interest, taxes, depreciation, and amortization) instead of EBIT to focus on cash-generation potential rather than accounting profit. A higher ratio indicates greater capacity to service interest expense.
Common formulas
- Basic: EBITDA ÷ Interest Expense
- With lease adjustment (used by some lenders): (EBITDA + Lease Payments) ÷ (Interest + Lease Payments)
A ratio above 1 means a company generates enough EBITDA to cover its interest obligations; higher values imply more cushion.
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Step-by-step example
Assume:
– Revenues = $1,000,000
– Operating expenses (excluding depreciation and interest) = $370,000 (salaries $250,000 + utilities $20,000 + lease payments $100,000)
– Depreciation = $50,000
– Interest expense = $120,000
- Calculate EBIT:
- EBIT = Revenues − Operating expenses − Depreciation
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EBIT = $1,000,000 − $370,000 − $50,000 = $580,000
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Calculate EBITDA:
-
EBITDA = EBIT + Depreciation = $580,000 + $50,000 = $630,000
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Compute coverage ratios:
- Basic: EBITDA ÷ Interest = $630,000 ÷ $120,000 = 5.25
- Including lease adjustment: (EBITDA + Lease) ÷ (Interest + Lease) = ($630,000 + $100,000) ÷ ($120,000 + $100,000) = 3.32
How to interpret the number
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1: EBITDA exceeds interest expense (company can cover interest from operating earnings).
- Larger ratios offer more cushion against earnings volatility.
- “Good” benchmarks vary by industry, business stability, and capital intensity; many lenders prefer coverage in the 2–3× range or higher for predictable businesses, while cyclical or capital-intensive firms may require greater coverage.
Limitations and caveats
- EBITDA excludes depreciation and amortization, so it can overstate available cash for companies with significant capital expenditure needs.
- EBITDA ignores taxes, principal repayments, and changes in working capital.
- Accounting choices and one-time items can distort EBITDA (adjusted EBITDA).
- Lease accounting standards and treatment can affect whether leases are added back.
- Relying solely on this ratio can mask liquidity issues; complement it with cash-flow and leverage metrics.
Complementary metrics to check
- EBIT (earnings before interest and taxes) ÷ Interest
- Free Cash Flow ÷ Interest or Free Cash Flow to Debt Service
- Debt-to-EBITDA (leverage)
- Current ratio or operating cash flow coverage
Practical tips
- Use trailing twelve months (TTM) figures for recent performance.
- Adjust for non-recurring items to get a normalized EBITDA.
- Compare against industry peers and historical company trends.
- For capital-intensive businesses, emphasize cash-flow measures and consider using EBIT for coverage analysis.
Key takeaways
- The EBITDA-to-interest coverage ratio helps assess a firm’s ability to service interest from operating earnings.
- It’s useful for quick screening but has material limitations—especially for companies with high capex or volatile earnings.
- Use it alongside other liquidity and leverage measures and apply conservative adjustments where appropriate.