Coefficient of coverage

Coefficient of coverage is a way to measure a company's solvency to repay interest accrued on loans. It is calculated as follows: the profit of the firm is divided by the amount of the total debt payable (interest on loans and taxes).

An extremely low ratio means that the company is not able to take care of interest payments in the short term, still has capital in reserve for everyday operations or unforeseen expenses.

Coefficient of coverage is an excellent method for investors to determine the financial stability of enterprises. Paying interest on loans for most of them is an extremely important indicator of successful development. Failure to pay interest on any loans is a sign of weakness, debt burden, and may be a harbinger of a possible bankruptcy of business.

Sometimes the coverage factor Investment , based on the ratio of interest received, is designed to show how much time the company will need to pay interest. This can be an excellent indicator of the organization's short-term financial stability.

When calculating the interest received for a particular company, the profit before interest and taxes must be summed up. The resulting number is then divided by the total, payable, interest (for all debts). Both numbers are taken for accuracy in accordance with a predetermined period of time for calculations. For example, an enterprise accumulates profit in a certain period of time 50,000 rubles. This is the amount that it earned before taxes and interest on loans were paid. For the same period of time, the interest due is 20,000 rubles. It is necessary to divide 50 000 (rubles) into 20 000 (rubles). Coefficient of coverage Will be 2.5, which essentially means the following: an enterprise is capable of paying interest obligations 2.5 times before the capital is over.

The low ratio, suppose if it dropped to the base level of 1.0, may be problematic, but for the time being the company's profits (before interest and taxes are paid) are enough to pay off its interest expenses. Below 1.0 indicates that the business is experiencing difficulties, generating cash needed to pay interest on loans. While there are some guidelines, there is no absolute or reference number that will serve as a guide for an acceptable KP.

For enterprises with unsustainable industries, a higher ratio is usually required to maximize control over potential ups and downs, while in sustainable industries it may not be high. It is not good when the firm has at times excessively high interest received. This means that she spent too much of her capital, pays cash for debts rather than investing in the development and growth of business.

To determine whether the company has sufficient liquid assets (excluding slow-moving inventories) for paying short-term liabilities (current liabilities), a sophisticated (or intermediate) coefficient is used Coating . Liquid assets include circulating inventories that can quickly be converted into cash, close to book value. Enterprises with a liquidity ratio of less than 1.0 are not in a position to pay off current debts.

For bond owners, the coverage ratio is presumably acting as a security tool. He gives an understanding of how much a company's profits can fall before it can not meet its payment obligations. For shareholders, it is important, because it shows a clear picture of the short-term financial health of the business.