Stock ratios say how big the debt is. Coverage ratios say whether this year's earnings carry it. Four instruments, from bluntest to sharpest:
Interest coverage / times interest earned. TIE = EBIT ÷ interest expense. Why EBIT and not net income? Interest is paid out of operating profit before tax. And why not EBITDA in the first cut? Because depreciation eventually comes back as real capex. Read the bands as rules of thumb. Above 8× the company is essentially unconstrained, and 4 to 8× is comfortable. At 2 to 4×, leverage is a live constraint on strategy. Below 2× you're in a distress conversation. Below 1×, operating profit no longer covers interest, and the company is borrowing to pay its lenders.
What is a good interest coverage ratio?
These bands are the raw material of synthetic credit ratings. Damodaran's tables map interest coverage to a rating and from there to a default spread. Coverage of ≳8.5× maps to AAA-grade and ~3× to BB-grade. The cost-of-capital work uses that same mapping to estimate the cost of debt for unrated firms.
Take one live example, Verizon (illustrative, ~FY24 scale). EBIT of ~$29bn against interest of ~$6.5bn gives TIE ≈ 4.4×. EBITDA of ~$48bn gives EBITDA/interest ≈ 7.4×, and net debt of ~$140bn is near 2.9× EBITDA. On a steel company those coverage numbers would alarm you. On subscription-grade telecom cash flows they're ordinary. That's what the sector tables are for.
EBITDA/interest is the same idea with a friendlier numerator. Lenders quote it because EBITDA approximates pre-capex operating cash. Always read it next to capex intensity. For an asset-light IT-services firm, EBITDA/interest ≈ cash reality. For a telecom or an airline, depreciation is merely deferred interest on assets that have to be bought again. Buffett's jab belongs here as a permanent footnote. Managements who tout EBITDA, he said, seem to believe the tooth fairy pays for capital expenditure.
Advertisement
What is the debt service coverage ratio?
Interest isn't the whole bill. Principal comes due too, and the lender's own ratio measures both. DSCR = cash available for debt service ÷ (interest + scheduled principal repayments). In quick screens the numerator is EBITDA. Project-finance practice refines it to CFADS, which is EBITDA − cash taxes − maintenance capex ± working-capital movement. In Indian infrastructure and global project finance, lenders covenant DSCR at ≥1.2 to 1.3×. Anything ≥1.5× is comfortable. Below 1.0× the project can't pay its schedule from its own cash. It has to refinance or default.
Try a small synthetic toll road. EBITDA is ₹450 cr and cash taxes are ₹30 cr, so CFADS is ₹420 cr. Interest of ₹180 cr plus principal of ₹150 cr makes ₹330 cr of debt service. DSCR = 420/330 = 1.27×. That passes a 1.25× covenant with almost nothing to spare, and the thin margin is the finding.
What is fixed-charge coverage?
Rent is as contractual as interest. Skip either and you lose the asset. For rent-heavy businesses (retail, restaurants, airlines, hotels), TIE flatters shamelessly, because rent was already deducted above EBIT while debt interest wasn't. Fixed-charge coverage is the lease-adjusted repair:
Fixed-charge coverage (FCC) = (EBIT + fixed charges) ÷ (interest + fixed charges), where fixed charges = rent/lease cost. Some conventions also add preferred dividends.
Here it is on a real specimen (illustrative, ~FY24 scale, pull the 10-K). Chipotle runs ~3,700 restaurants, essentially all of them leased. It carries no borrowings at all. Interest coverage is EBIT ~$1,920m ÷ ~$0, which comes out undefined or infinite. "The safest balance sheet in the industry." Now count the rent. Occupancy cost is ~$550m/yr. FCC = (1,920 + 550) ÷ (0 + 550) = 2,470/550 ≈ 4.5×. Still healthy, but finite. The leases are the debt, and ~$4.6bn of operating-lease liabilities appear on the balance sheet under ASC 842. A company with zero debt and 4.5× fixed-charge coverage is a normal, moderately committed credit. There's no miracle in it. Worked example 1 finishes the computation, including the lease-adjusted leverage ratio.
How do you compare coverage across US GAAP and IFRS?
The cross-standard wrinkle from the liabilities work now matters in practice. Under ASC 842, operating-lease cost is inside opex as rent, so EBIT is after rent and FCC's add-back works directly. Under IFRS 16/Ind AS 116 there's no rent line. Instead, the same lease shows up as ROU depreciation plus lease interest. The portable fix is the airline and retail convention. Compute EBITDAR and cover it against interest + total lease cash payments. For a US GAAP reporter, EBITDAR is EBITDA + rent. For an IFRS/Ind AS reporter it's EBITDA as reported, since lease costs are already below it. Now the numerator and the denominator are both consistent, and the ratio compares across the border. Practice P8 has you prove the two routes converge on identical twins.
Always pair stock with flow. Net debt/EBITDA tells you how big the debt is. DSCR or FCC tells you whether this year can pay it, and the maturity schedule in the borrowings note tells you when it comes due. Read together, they're the complete solvency read. Any one of them alone can be gamed, but the three rarely lie together.