Fixed Charge Coverage Ratio:

 

Fixed Charge Coverage Ratio: Formula and How to Calculate

The fixed charge coverage ratio (FCCR) shows how well a business can pay its fixed expenses, including mandatory debt payments and interest.

Lenders and investors often use this metric to determine whether to approve a loan application or invest in the business. Here’s what you need to know about the fixed charge coverage ratio and how to calculate it.

What is the fixed charge coverage ratio?

The fixed charge coverage ratio measures a company’s ability to meet fixed charges from its earnings before interest and taxes (EBIT). Examples of fixed charges include insurance premiums and lease and loan payments because the same amount is due each month, no matter how much revenue the company earns.

Essentially, the FCCR shows how many times over your business can satisfy its predictable financial responsibilities. An FCCR of 1 means you have just enough earnings before interest and taxes to meet them. An FCCR of 2 shows you could pay them all two times over.

The ideal FCCR varies by industry, but many lenders look for borrowers to have a ratio of at least 1.2.

How to calculate fixed charge coverage ratio

Here is the fixed charge coverage ratio formula:

Fixed charge coverage ratio formula =

(EBIT + fixed charges before taxes) / (fixed charges before taxes + interest)

·         EBIT: earnings before taxes, calculated by adding tax and interest expenses back to your net income

·         Fixed charges: Recurring business expenses that are paid regardless of sales volumes, such as debt and lease expenses

To calculate your FCCR, add the company’s earnings before interest and taxes to its fixed obligations before tax. Then divide that total by the sum of fixed charges before tax plus interest.

The resulting number represents how solvent your company is, with a higher number (2 or above) indicating a healthier company with less financial risk. Conversely, a ratio below 1 means you may have problems meeting your regular financial obligations, and a sudden drop in earnings could be disastrous.

Fixed charge coverage ratio examples

Here are two examples to help you better understand how to calculate your fixed charge coverage ratio — one with a higher FCCR and one with a lower ratio.

Higher FCCR

Company A has earnings before interest and taxes of $650,000. It pays $10,000 per month for a building lease, $100,000 annually for equipment, $30,000 per year in principal payments towards loans and $80,000 annually in interest payments.

Based on the numbers below, here’s how Company A would calculate its FCCR.

·         EBIT: $650,000

·         Fixed charges before taxes:

·         Equipment expenses: $100,000

·         Annual lease: (monthly $10,000 x 12 months) = $120,000

·         Annual principal on a loan: $30,000

·         Annual interest payments: $80,000

With an FCCR of 2.72, Company A could pay its fixed charges close to three times over from its earnings before interest and taxes. That’s a healthy number and likely means Company A wouldn’t have too much trouble getting a business loan or finding investors.

Lower FCCR

Company B has earnings before interest and taxes of $200,000. It pays $5,000 per month for a building lease, $70,000 annually for equipment, $20,000 per year in principal payments towards secured business loans and $50,000 annually in interest.

Based on the numbers below, here’s how Company A would calculate its FCCR.

·         EBIT: $200,000

·         Fixed charges before taxes:

·         Equipment expenses: $70,000

·         Annual lease: (monthly $5,000 x 12 months) = $60,000

·         Annual principal on a loan: $20,000

·         Annual interest payments: $50,000

Company B’s FCC ratio is 1.75. That means Company B’s earnings before interest and taxes are 1.75 times higher than its fixed expenses. While its FCCR isn’t as high as Company A’s, it’s still above the typical 1.2 required by many lenders. So the company may be able to get a business loan, but it might not have as many options — or get a competitive interest rate offer — as Company A.

 

Fixed charge coverage ratio vs. times interest earned

The times interest earned (TIE) ratio is also a measurement of a company’s ability to meet its obligations. However, it focuses solely on debt obligations, whereas the FCCR takes into account all fixed charges.

You calculate the TIE ratio by dividing a company’s earnings before interest and taxes by its periodic interest expense.

TIE formula: TIE ratio = EBIT / interest expense

A company with a TIE of 2 could pay its periodic interest payments twice over if it devoted all of its earnings before interest and taxes to debt repayment.

 

IFRS BASED FINANCIAL STATEMENTS

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RATIO ANALYSIS\

 Ratio Analysis

A financial ratio is a relationship of two values of financial statements. Ratios basically are mathematical expressions, which are calculated to derive certain conclusion. The ratio may be expressed as number of times, proportion or percentage. There are number of ratios, but which to consider for a particular type of analysis is left to the personal judgement of the analyst. As a matter of fact, all the ratios are for different purposes and have different objectives.

	Uses of Ratios.
Sr. No.
1	Ratios offer help in intra firm comparisons, industry comparison and
	also for inter-firm comparison.
2	Financial position of the entity can be studied.

	3.0 Limitations & problems of Ratio analysis:
Sr. No.	Limitations
1	Ratios are based on financial statements, so contain almost all of the deficiencies of those accounts.
2	Some ratios are open for manipulation and need to be interpreted with care. E.g. stock levels may be kept artificially low at year-end, creating an impression of high efficiency in this area.
3	Inter-firm comparisons are faced with the problem that different organizations might use rather different accounting policies. E.g. depreciation methods etc.
4	Detailed knowledge of a company’s markets is seldom obtainable from the published accounts, but is extremely important for assessing future profitability.
5	Ratios are useful when comparing similar organizations operating under similar conditions. Comparisons with different types of organizations can be misleading.
6	There is a real danger that ratio analysis can lead to conclusions, which are over-simplified. e.g. high current ratio.

 Types of Ratios.  Interpretation of various Ratios:  Other Ratios:

Sr. No.	Type of Ratio	Various ratios
1	Turnover Ratios	Debtors, Creditors, Inventory
2	Liquidity Ratios	Current, Acid test
3	Profitability Ratios	Gross profit, Net profit
4	Solvency Ratios	Debt Equity, Interest coverage, DSCR

Sr. No.	Ratios	Formula / Interpretation
1.0	Turnover Ratios:
1.1	Debtors Turnover Ratio	Average Debtors x 365 divided by Sales. Average Collection period.
1.2	Creditors Turnover Ratio.	Average Creditors x 365 divided by Credit purchases. Average payment period.
1.3	Inventory Turnover Ratio.	Average inventory x 365 divided by material cost Holding period of stock

Sr. No.	Ratios	Formula / Interpretation
2.0	Liquidity Ratios:
2.1	Current Ratio	Current Assets / Current Liabilities.
2.2	Acid Test Ratio	Quick Assets / Quick liabilities.
	Cash Ratio	Cash & cash Equivalent/current Liabilities

Sr. No.	Ratios	Formula / Interpretation
3.0	Profitability Ratios:
3.1	Gross Profit Ratio	Gross profit / Net sales x 100
3.2	Net Profit Ratio	Net profit / Net sales x 100
3.3	Material cost ratio	Material cost / Net sales x 100
3.4	Expenses Ratios	Expenses / Net sales x 100
3.5	Return on Capital	PBIT / Capital employed x 100
3.6	Return on Proprietor’s Funds	PAT / Proprietor’s Funds

Sr. No.	Ratios	Formula / Interpretation
4.0	Solvency Ratios:
4.1	Debt Equity Ratio	Total outside debt / Equity or Shareholders’ funds.
4.2	Proprietary Ratio	Proprietor’s funds /Total Assets x 100
4.3	Interest coverage Ratio	PBIT / Fixed interest charges
4.4	Debt coverage Ratio	PATID / (Interest + Repayment installments)

Notes	Ratio	Components
1	Average debtors	Opening debtors + Closing debtors divided by 2
2	Current assets	Stock + debtors + cash & bank balance + loans & advances + Prepaid expenses
3	Current liabilities	Creditors + BP + O/S expenses + IT payable + Dividend payable + Bank overdraft ( not if permanent)
4	Quick Assets	Current Assets less ( Stock + prepaid expenses)
5	Quick Liabilities.	Current liabilities less Bank overdraft
6	Gross Profit	Sales less material cost.
7	Net Profit	Sales less all expenses + any other income.
8	Debt	Long term loans + debentures + Bank overdraft
9	Equity	Equity share capital + Preference share capital +Free Reserves – (Accumulated losses + deferred revenue expenditure) = Net worth = Proprietor’s funds.
10	PBIT	Profit before Tax + interest.
11	PATID	Profit after Tax + Interest + Depreciation. = Annual cash flow.
12	PAT	Profit less I. Tax.
13	Capital employed	Net Fixed Assets + Current assets less Current liabilities.

Sr. no.	Ratio
1.0	Turnover Ratios:
1.1	Debtors Turnover Ratio: This ratio measures the average number of day’s credit given to debtors. It helps to assess the efficiency of the
	debt collection department. Debt collection period should be kept as low as possible, consistent with maintaining customer goodwill and market trend.
1.2	Creditors Turnover Ratio: This ratio measures the average number of days credit is exploited from suppliers. Credit given by suppliers depends on various factors such as demand & supply position of material, industry trends, competition etc.
1.3	Inventory Turnover Ratio: This ratio measures the average number of days for which stock is held. It helps to assess the efficiency of stock
	utilization. Various factors affect the stock level held by the
	organization such as product, production-seasonal or otherwise,
	demand pattern, competition, funds availability etc.

2.0	Liquidity Ratios:
2.1	Current Ratio: This ratio is concerned with the assessment of an
	organization's ability to meet its short-term obligations. The ratio must be high enough for safety. However, high current assets do not normally lead to high profits in themselves, so the usual trade-off between risk and return exists. Industry norm is 2:1
2.2	Acid Test Ratio: This ratio is also concerned with short-term liquidity. In a sense it is more appropriate measure since liquid assets represent the source of funds from which current liabilities will probably be met. Industry norm is 1:1
3.0	Profitability Ratios:
3.1	Gross Profit Ratio: GP / Margin on sales
3.2	Net Profit Ratio: Net profit on sales. It indicates organization's ability
	to generate profits from sales.
3.3	Material cost ratio: Material cost to sales
3.4	Expenses Ratios: Expenses to sales.
3.5	Return on Capital: This ratio is expressed as a percentage. Generally
	higher the return the better.
3.6	Return on Proprietor’s Funds: This ratio provides a measure of the
	percentage return on the investment made by the owners.
4.0	Solvency Ratios:
4.1	Debt Equity Ratio: This ratio is concerned with establishing the relationship between external and internal long-term financing. The
	use of long-term debt in the capital structure has both advantages and
	disadvantages, and in practice the level of debt actually existing is the
	result of a balancing process. The main advantage of debt is that it
	provides an opportunity for greater returns to shareholders. Industry norm is 2:1
4.2	Proprietary Ratio: It measures the owner's contribution of funds.
4.3	Interest coverage Ratio: This ratio measures the safety available to
	Bank for recovery of interest. Industry norm is 2:1
4.4	Debt coverage Ratio: This ratio measures the safety available to Bank
	for recovery of interest & loan installment. Industry norm is 2.5 : 1

6.1	Employees Ratios:
¾	Sales per employee:	Sales / staff strength
¾	Sales generation:	Sales / salaries & wages
¾	Profit per employee:	PBT / staff strength
¾	Profit generation:	PBT / salaries & wages
¾	Remuneration level:	Salaries & wages / staff strength
6.2	Shareholder's Ratios:
¾	Earnings per share:	PAT less Pref. Dividend / number of shares
¾	Dividend per share:	Dividend / Number of shares
¾	Dividend pay out ratio:	Dividend / Earnings per share
¾	Dividend yield:	Dividend per share / Market price per share
¾	Book value per share:	Ordinary shareholder's equity / number of shares
¾	Price-earnings ratio:	Market price per share / Earnings per share.