Financial Ratio Analysis - Interest cover

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Interest cover

The interest cover ratio tells us the safety margin that the business has in terms of being able to meet its interest obligations. That is, a high interest cover ratio means that the business is easily able to meet its interest obligations from profits. Similarly, a low value for the interest cover ratio means that the business is potentially in danger of not being able to meet its interest obligations.

The Carphone Warehouse Consolidated Profit and Loss Account	31 March 2001	25 March 2000
	£'000	£'000
Profit before interest and taxation	45,012	25,300
Net interest receivable (payable)	2,385	-196

Here's a reminder of the formula:

Interest Cover	=	Net profit before interest
		Interest paid

Here's the first interest cover value calculated for you, now you work out the value for the missing one.

	31 March 2001		25 March 2000
Profit before interest and taxation	45,012	18.87
Net interest receivable (payable)	2,385	18.87

Did you get this?

In 2001, the Carphone Warehouse had no problem with its interest obligations since it was a net receiver of interest: the interest it earned was greater than the interest it might have had to pay. For the previous year, though, its interest obligations were negative, meaning that it needed to pay more interest than it had earned. However, at 129.08, its interest cover ratio is more than satisfactory as it means that the necessary profit is 129.08 times larger than the interest payments that the business had incurred.

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