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.
EBITDA coverage ratio is broader than the times interest earned ratio, which measures a company’s ability to pay interest charges on debt. EBITDA approximates a company’s cash flows more closely than its earnings do (because it excludes non-cash expenses of depreciation and amortization). Since debts are to be repaid using the cash flows generated, EBITDA coverage is a useful measure of a company’s ability to pay off its debt repayment obligations.
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 income | 2,000,000 |
| Income tax expense | 857,143 |
| Interest 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 | = 1.78 |
| 1,000,000 + 2,000,000 + 800,000 |
EBIT = 2,000,000 + 857,143 + 1,000,000 = 3,857,143
| Times Interest Earned = | 3,857,143 | = 3.86 |
| 1,000,000 |
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.
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