Leverage Ratio:Net Interest Cover or Times Interest Earned

June 8th, 2006 Comments off
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We now look at the financial ratio for assessing the LEVERAGE or gearing of a company.Essentially, the Leverage Financial ratio should be able to measure the amounts of  borrowed money being used by the firm.

 

Leverage Ratios are classified as either:-

 

  • Capitalization Ratios, focusing on how investments are financed; or

 

  • Coverage Ratios, focusing on the ability to service the firm’s sources of financing.

 

 

       NET INTEREST COVER / TIMES INTEREST EARNED

FORMULA

Earnings Before Interest & Tax (EBIT) / Interest

MEASURE  WHAT

Measures the extent of which earnings are available to meet interest payments

SCORE OR VALUE

Varies with industry.

Larger is safer

>3:1  Strong

>2.5:1 Acceptable

>1:1  Evidence of weakness

<1:1  Problems present

SALIENT POINTS TO NOTE:

A lower net interest cover means less earnings are available to meet interest payments and that the business is more vulnerable to increases in interest rates.

Should consider stability and quality of earnings ( and cash flows)

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Financial Accounting

 
 

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