What does the interest coverage ratio measure?

The interest coverage ratio specifically measures a company's ability to meet its interest obligations on outstanding debt with its earnings before interest and taxes (EBIT). This ratio is calculated by dividing EBIT by interest expense. A higher ratio indicates that the company generates sufficient earnings to cover its interest payments, suggesting a lower risk of default. It is an important indicator of financial health, especially for creditors and investors who want to understand the company’s capacity to manage its debt obligations.

While profitability, liquidity, and operational efficiency are critical aspects of a company's overall financial health, they are not the focus of the interest coverage ratio. Instead, this ratio directly addresses the risk associated with debt financing and the company's ability to sustain its interest payments, which is crucial for assessing financial stability.