What is the fixed charge coverage ratio and how is it calculated?

Question: What is the fixed charge coverage ratio and how is it calculated?

Answer:

The fixed charge coverage ratio is a broader measure of how well a firm covers their fixed costs than the times interest earned ratio.

The fixed charge coverage ratio includes lease payments as well as interest payments. Lease payments, like interest payments, must be met on an annual basis. The fixed charge coverage ratio is especially important for firms that extensively lease equipment, for example.

Here is the calculation for the fixed charge coverage ratio:

Earnings Before Interest and Taxes (EBIT) + Lease Payments/Interest Expense + Lease Payments = # Times

Interpretation: EBIT, Taxes, and Interest Expense are taken from the company's income statement. Lease Payments are taken from the balance sheet and are usually shown as a footnote on the balance sheet. The result of the fixed charge coverage ratio is the number of times the company can cover its fixed charges per year. The higher the number, the better the debt position of the firm, similar to the times interest earned ratio.

Like all ratios, you can only make a determination if the result of this ratio is good or bad if you use either historical data from the company or if you use comparable data from the industry.