Interest Coverage

Interest coverage measures the ability of a firm to meet its debt interest payments.

The larger the interest coverage ratio, the more likely the firm can meet its payments. The lower the ratio, the greater the risk that the company may default on its loans.

The ratio divides operating income (income before interest and taxes, or EBIT) by debt interest:

Calculating Interest Coverage

Operating Income/Debt Interest Expense

Analysts typically require minimum interest coverage ratios of four to qualify for strong credit ratings.

The following table shows the interest coverage for the Software Industry, Microsoft, the S&P 500, Luxottica Group, Specialty Retail, and Sunny Sunglasses Shop.

Company	Interest Coverage
Microsoft	41.9
Software Industry	27.3
S&P 500	27.2
Sunny Sunglasses Shop	10.3
Specialty Retail, Other	9.4
Sunglasses Hut Int. (Luxottica Group)	6.9

Microsoft and the software industry generally have very high operating margins and low debt interest, creating very high interest coverage ratios.

The retail industry, on the other hand, has lower operating margins than software, resulting in less operating income to cover debt interest expenses.

Sunny Sunglasses Shop has ten times the operating income to cover its debt interest. This is more than enough to receive a strong credit rating and higher than the industry average of 6.9. Luxottica Group, also with a relatively strong operating margin, has seven times the income to cover its debt interest.

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