One Of The Biggest Reasons For Losses In This Stock Market Is Investing In Companies That Are Not Financially Strong. Because Even The Slightest Financial Problem On Such Companies Has A Very Bad Effect, Due To Which Their Stocks Crash. For This Reason, It Is Very Important That We Avoid Investing In Financially Weak Companies.
Friends, In This Post We Will Know The Interest Coverage Ratio Which Can Save Us From Investing In Financially Weak Companies. We, Will, Know What Is The Interest Coverage Ratio. How Is It Calculated And How Should We Use It.
Hello, Friends Welcome To Our Blog. So Let’s Start.
What Is The Interest Coverage Ratio?
Let Us Know What Is The Interest Coverage Ratio is.
Friends, Interest Coverage Ratio Is A Financial Ratio That Tells Us How Easily A Company Can Make Interest Payments On Its Loan. The Higher The Interest Coverage Ratio Of A Company, The More Financially Strong That Company Is.
Friends, The Formula For The Interest Coverage Ratio Is:
Interest Coverage Ratio = Earnings Before Interest And Taxes(EBIT) / Interest Expanse
Here Earnings Before Interests And Taxes (EBIT) Means Operating Profit Of The Company. And The Interest Expense Means The Total Interest The Company Is Paying On Its Loans In A Year. We Get Both The Earnings Before Interest And Taxes And Interest Expense From The Income Statement Of The Company.
How Is The Interest Coverage Ratio Calculated?
For Example, Let’s Assume That Ab Ltd Is A Company Whose Income Statement Is Something Like This:
Let Us Calculate The AB Limited Interest Coverage Ratio. Friends, The Formula For The Interest Coverage Ratio Is
Interest Coverage Ratio = (EBIT) / Interest Expanse
Here The Earnings Before Interest Taxes Of Ab Ltd. Is Rs.12 Crores And The Interest Expense Is Rs.2 Crores? In This Way The Interest Coverage Ratio Of AB Ltd. Will Become.
Interest Coverage Ratio = 12/2 = 6
This Means That AB Ltd.’S Operating Profit Is 6 Times Its Annual Interest Expense And AB Ltd. Can Easily Pay Its Interest Out Of Its Operating Profit.
How To Use The Interest Coverage Ratio?
With The Interest Coverage Ratio, Lenders, Creditors And Investors See How Risky It Can Be To Give Any Kind Of Loan To The Company. The Lower A Company’s Interest Coverage Ratio, The More Difficult It Is For That Company To Pay Interest From Its Operating Profit.
Investors Generally Consider Those Companies To Be Financially Strong With An Interest Coverage Ratio Of Three Or More. And As The Interest Coverage Ratio Of A Company Falls Below Three, That Company Becomes Riskier In The Eyes Of Investors. If The Interest Coverage Ratio Of A Company Is Less Than One, It Means That The Company Is In A Very Weak Position Financially. Because Interest Coverage Ratio Less Than 1 Indicates That The Company Is Not Even Able To Pay Its Interest From Its Operating Profit And The Company May Be Bankrupt In Some Time To Come.
Friends, We Do Not Need To Calculate The Interest Coverage Ratio By Ourselves. Often Companies Themselves Show This In Their Annual Reports Or We Can Easily See It On Many Websites Like Screener. In Or Moneycontrol.Com.
Friends, Along With Looking At Today’s Interest Coverage Ratio Of Companies, We Should Also See Its Year After Year Trend.
For Example, Let’s Assume That AB Ltd. And DC Ltd. Are Companies And The Interest Coverage Ratio Of Both The Companies For The Last Five Years Is As Follows:
Here We Can See That The Interest Coverage Ratio Of AB Ltd. Has Consistently Improved Since 2016 Which Means That AB Ltd. Is Continuously Making Itself Stronger. At The Same Time, The Interest Coverage Ratio Of DC Limited Has Been Continuously Decreasing Since 2016 Which Means That Due To Some Reason Or The, DC Limited Is Becoming Financially Week Year After Year.
In This Way, We Can Understand From The Trend Of Interest Coverage Ratio Of Companies Whether Companies Are Making Themselves Financially Strong Over Time Or Financially Week.
So, Friends, This Was Our Post Today, It Was Above The Interest Coverage Ratio. In This, We Learned What Is The Interest Coverage Ratio is, How It Is Calculated, And How We Should Use It. If You Liked This Post, Then Definitely Share This Post And If You Want To Ask Any Question About This Issue, Then Definitely Write It In The Comment Box Below.
