Interest coverage ratio
The interest coverage ratio compares a business’s earnings with the interest it owes. Government sources calculate it differently: ISED adds interest and bank charges back to net profit, while Statistics Canada uses net income before taxes over investment interest expense.
A buyer financing an acquisition may meet this ratio if a lender tests whether the earnings of the business can carry the interest on the new debt. It looks only at interest, so it is a narrower test than the debt service coverage ratio, which BDC says also counts principal.
Two published formulas
- ISED’s Financial Performance Data glossary calculates it as net profit plus interest and bank charges, divided by interest and bank charges.
- Statistics Canada calculates it as net income before taxes divided by investment interest expense.
The two do not use the same numerator, so a figure quoted without its formula cannot be compared with another.
What to ask a lender
Ask which earnings measure the lender uses, whether the test is written into the loan agreement, and whether it is measured on past results or on the projected figures after closing. If it is a covenant, see what the loan agreement says happens on a breach. Our guide to loan covenants in an acquisition covers how to read them.
Sources
This definition is checked against primary sources. Links were last confirmed on the dates shown.
- 01Innovation, Science and Economic Development CanadaGovernmentGlossary - Financial Performance Data
- 02Statistics CanadaResearch dataMethodology used to create enterprise size and financial ratios
- 03Business Development Bank of CanadaGovernment4 types of financial ratios to assess your business performance
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