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What is the Interest Coverage Ratio (ICR)?

The Interest Coverage Ratio (ICR) measures how easily a company can pay its interest obligations from operating earnings. A ratio below 1.5 is a warning sign; below 1.0 means the company cannot cover interest from operations alone, suggesting financial distress. Lenders and credit analysts use ICR as a primary covenant metric to assess a borrower's ability to service its debt without relying on asset sales or new financing.

Formula

ICR = EBIT / Interest Expense

ICR as a Credit Quality and Distress Signal

Investment-grade debt covenants typically require a minimum ICR of 2.0-3.0x. When a company's ICR falls below covenant thresholds, lenders can accelerate repayment or take control, making ICR a direct trigger for credit events. Credit rating agencies like Moody's and S&P incorporate ICR into their scoring models: investment-grade bonds (BBB- and above) typically require sustained ICR above 2.0x.

For equity investors, a deteriorating ICR trend is a leading indicator of potential dilution: when a company cannot service debt from operations, it often issues new equity to raise cash -- diluting existing shareholders. Monitoring ICR alongside net debt / EBITDA gives a complete picture of near-term debt service risk.

Model WACC and Debt Cost

ICR connects directly to a company's cost of debt. Use our WACC Calculator to see how interest expense and capital structure interact in valuation models.

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Frequently Asked Questions

What is the Interest Coverage Ratio?+
The Interest Coverage Ratio (ICR) -- also called the Times Interest Earned (TIE) ratio -- divides Earnings Before Interest and Taxes (EBIT) by total interest expense for the same period. It answers: how many times over could the company pay its interest bill from operating profit alone? A ratio of 5.0 means operating earnings are five times the interest expense. A ratio of 0.8 means the company earns only 80 cents in operating profit for every $1.00 of interest it owes -- a clear distress signal.
What is a good Interest Coverage Ratio?+
General benchmarks: above 3.0 is comfortable and indicates the company can service debt even if earnings decline significantly; 1.5 to 3.0 is acceptable but leaves limited buffer against earnings deterioration; below 1.5 is risky and may trigger covenant breaches in loan agreements; below 1.0 means the company is in or near financial distress and is covering interest through asset sales, new debt issuance, or drawing down cash reserves. Capital-intensive industries like utilities and real estate often operate with lower ICRs by design, because their cash flows are more predictable.
How does ICR compare to the Altman Z-Score?+
The Altman Z-Score is a bankruptcy prediction model that uses five financial ratios. One component -- EBIT / Total Assets -- measures operating return on assets, conceptually similar to ICR in that both use EBIT as the numerator. However, the Altman model uses total assets in the denominator (a balance sheet leverage measure), while ICR uses interest expense (a cash outflow measure). Together they capture different dimensions of debt service capacity: ICR tells you if earnings cover cash interest costs; the Z-Score EBIT/Assets ratio tells you if the asset base is generating adequate operating returns.
How do leveraged buyouts affect ICR?+
Leveraged buyouts (LBOs) fund acquisitions primarily with debt -- often 60-80% of the purchase price. This stacks interest expense immediately on top of the target's EBIT, compressing the ICR dramatically. Newly LBO'd companies commonly exit with ICRs of 1.5-2.0 by design: private equity sponsors model this level as serviceable if the business performs to plan, while building in cushion through cash flow sweeps and PIK (payment-in-kind) interest structures. Analysts evaluating LBO targets closely monitor whether post-transaction ICR can be maintained above 1.5x through the investment horizon.

Related Terms

Net Debt

Total debt minus cash and equivalents

EBITDA

Earnings before interest, taxes, depreciation, and amortization

Debt-to-Equity Ratio

Financial leverage measured by debt vs equity

ROCE

Operating profit as a return on all capital deployed

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