How to Calculate the Debt Coverage Ratio
Debt coverage refers to the amount of cash flow available to meet interest and principle payments on debt. There are three popular versions of debt coverage ratios, each of which entails its own method of calculation.
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Instructions
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Calculate the bondholders debt coverage ratio. This ratio measures how many of a company's assets are owned by debt and equity. Calculate this ratio by dividing "Total Liabilities" by "Stockholder's Equity." You can find these on the Balance Sheet. Investors in debt prefer this ratio, as it helps them to see what "coverage" is available in the event of bankruptcy.
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Calculate long-term debt coverage ratio. This ratio is used to get a "cleaner" understanding of long-term debt. By taking out short-term liabilities, the ratio compares long-term debt against long-term liabilities. The exact calculation is Long-Term Debt Coverage ratio = Long-Term Debt / Stockholder's Equity.
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Calculate the interest coverage ratio. A company that is not making enough money to pay its interest expense will not survive. Therefore, it is common for creditors and investors to monitor the number of times earnings cover interest payments. Before you can calculate the interest coverage ratio, you must first calculate earnings before interest and taxes (EBIT).
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Calculate or locate EBIT. This number can be found on the Income Statement. It may need to be calculated manually. It is Net Income (NI) before interest and taxes or NI + Interest + Taxes. Interest is tax-deductible. If you are analyzing a high capital (assets) business, you might want to look at EBIT before Depreciation and Amortization (EBITDA).
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Find the Interest for Long-Term Debt in the 10K notes to financial statements section. Divide EBIT or EBITDA by Interest for Lon-Term Debt. This is the interest coverage ratio. A higher number is better than a lower number.
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This is not to be construed as investment advice.
