Interest Coverage Ratio

The interest coverage ratio (also called times interest earned) divides earnings before interest and taxes by interest expense. It measures the cushion between what the business earns and what its lenders must be paid — a cushion that trade creditors care about because interest is paid before, and usually instead of, stretched suppliers ever see a catch-up. Coverage above 3.0x is generally comfortable; 1.5x to 3.0x is tight; below 1.5x means a modest earnings dip puts debt service at risk.

Coverage deteriorates from two directions at once in a rising-rate environment or a downturn: EBIT falls while floating-rate interest expense climbs. A customer that comfortably covered interest at 4.0x two years ago can sit at 1.8x today without a single operational misstep. This is why coverage should be recomputed at every statement refresh rather than carried forward from the original underwriting.

Lender covenants often key off a related measure, the fixed charge coverage ratio, which adds lease payments and scheduled principal to the denominator. When a customer is near covenant levels, expect behavior changes that affect you: cash hoarding at quarter-end, slower payments in covenant-measurement months, and pressure to stretch trade payables — the cheapest and least-documented financing available to them.