Financial Glossary
Interest Coverage Ratio (ICR)
The Interest Coverage Ratio (ICR) measures how many times a company's operating earnings can cover its interest expense. Formula: ICR = EBIT / Interest Expense, where EBIT is earnings before interest and taxes. A ratio of 1.0x means every dollar of operating profit goes to interest -- no margin for error. Lenders typically require a minimum ICR covenant of 1.25x to 1.50x for commercial real estate loans and 2.0x or higher for unsecured business credit. A declining ICR over successive periods signals deteriorating debt serviceability even if the company remains technically profitable. It is a critical input in credit underwriting and debt covenant monitoring.
Problem & Application
An RV park secures a $2,000,000 acquisition loan at a 7% interest rate. Annual interest expense = $140,000. If the park's operating income (EBIT) is $280,000 in its first full year, ICR = 280,000 / 140,000 = 2.0x -- at the minimum comfort threshold for most lenders. If a wet summer season cuts EBIT to $175,000, ICR drops to 1.25x, potentially triggering a covenant-default notice even though no payment has been missed. For seasonal businesses like campgrounds, lenders often negotiate ICR covenants measured on a trailing 12-month basis rather than a single quarter to smooth seasonality. Maintaining adequate operating reserves -- typically three to six months of debt service -- provides buffer during slow periods and keeps the business within covenant compliance. Parikh Financial models ICR alongside DSCR in all acquisition underwriting for hospitality and real-estate operator clients.
In Short
The interest coverage ratio is a critical indicator of financial health, helping businesses assess their ability to service debt and manage borrowing costs.