The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. The interest coverage ratio may be calculated by dividing a company's earnings before interest and taxes during a given period by the company's interest payments due within the same period. Lenders, investors, and creditors often use this formula to determine a company's riskiness relative to its current debt or for future borrowing. It measures the margin of safety a company has for paying interest on its debt during a given period. The lower a company’s interest coverage ratio is, the more its debt expenses burden the company. When a company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses may be questionable.A result of 1.5 is generally considered to be a bare minimum acceptable ratio for a company and the tipping point below which lenders will likely refuse to lend the company more money, as the company’s risk for default may be perceived as too high. If a company’s ratio is below 1, it will likely need to spend some of its cash reserves in order to meet the difference or borrow more, which will be difficult for reasons stated above. Otherwise, even if earnings are low for a single month, the company risks falling into bankruptcy.
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