Interest cover

Interest cover is a measure of the adequacy of a company's profits relative to interest payments on its debt. The lower the interest cover, the greater the risk that profit (before interest) will become insufficient to cover interest payments. It is:

EBIT ÷net interest paid

It is a better measure of the gearing effect of debt on profits than gearing itself.

A value of more than 2 is normally considered reasonably safe, but companies with very volatile earnings may require an even higher level, whereas companies that have very stable earnings, such as utilities, may well be very safe at a lower level. Similarly, cyclical companies at the bottom of their cycle may well have a low interest cover but investors who are confident of recovery may not be overly concerned by the apparent risk.

If a company has capitalised interest, then it will not show the capitalised interest as interest paid in the profit and loss account (P &L).

When calculating interest cover capitalised interest should be included. The number used should be net interest paid as shown on the P & L plus interest capitalised. This is one of the problems avoided by using cash interest cover.

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