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
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FORMULA |
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Earnings Before Interest & Tax (EBIT) / Interest |
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MEASUREÂ WHAT |
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Measures the extent of which earnings are available to meet interest payments |
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SCORE OR VALUE |
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Varies with industry. Larger is safer >3:1 Strong >2.5:1 Acceptable >1:1 Evidence of weakness <1:1 Problems present |
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SALIENT POINTS TO NOTE: |
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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. |
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Should consider stability and quality of earnings ( and cash flows) |