EBITDA Coverage Ratio Mathematical Solution - QS Study

EBITDA Coverage Ratio is a solvency ratio that measures a company’s ability to pay off its liabilities related to debts and leases. It compares the company’s earnings before interest, tax, depreciation, amortization (EBITDA) plus lease payments to the sum of debt payments and lease payments.

Formula

EBITDA Coverage Ratio = (EBITDA + Lease payments) / (Interest Payments + Principal Repayments + Lease payments)

Where EBITDA is Earnings Before Interest, Tax, Depreciation, and Amortization. It can be calculated from net income as follows:

EBITDA = Net Income + Tax + Interest + Depreciation + Amortization

Example:

Calculate EBITDA coverage ratio and times interest earned ratio for Company ABC using the following information:

 Net incom 2,000,000 Income tax expense 857,143 Inerest expense 1,000,000 Lease payments 800,000 Principal repayment on debt 2,000,000 Depreciation 1,200,000 Amortization 900,000

The relevant industry average for EBITDA coverage and TIE is 2 and 3 respectively.

Solution:

EBITDA = 2,000,000 + 857,143 + 1,000,000 + 1,200,000 + 900,000 = 5,957,143

EBITDA Coverage Ratio = (5,957,143 + 800,000) / (1,000,000 + 2,000,000 + 800,000) = 1.78

EBIT = 2,000,000 + 857,143 + 1,000,000 = 3,857,143

Times Interest Earned = 3,857,143 / 1,000,000 = 3.86

EBITDA coverage ratio of 1.78 means that the company can safely pay off its periodic debt repayment obligations. However, it is below the industry average.

Times interest earned ratio of 3.86 tells that the company has the capacity to pay almost 4 times the current interest expense, and it is better than the industry average.