These ratios help to analyze the long term solvency of the firm. They determine whether the firm will be able to meet its financial obligations in the long run or not. The coverage ratios reflect the firm’s ability to meet fixed obligations such as lease payments, principal repayment or interest payments.
Interest coverage ratio- It compares the earnings available to meet the interest obligation with the current interest payment.
I.e. EBIT (Earnings before interest and tax)
Interest
Fixed charge coverage ratio- It measures the firm’s ability to meet not only the interest but also the other fixed charges such as lease payments, preferred dividends etc.
I.e. EBIT + Fixed charges
Interest + fixed charges
Debt service coverage ratio- It measures the company’s ability to pay the principal payments, interest payments, lease payments and also the sinking fund payments.
I.e.EBIT + depreciation
Interest+ Principal repayment + other fixed charges
Hence, this concludes the definition of Coverage Ratios along with its overview.
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