You’ve heard the term, “You’ve got to spend money to make money.”
If you’re a small business owner, you know it’s true. But where does that initial money come from? In most cases, people turn to banks for a loan to get their business up and running (or keep them going when the market shifts).
While this debt isn’t a bad thing in business, too much of it can eat into your profits. That’s why knowing how easily you can use your earnings to pay off existing loans is essential, and that’s where the interest coverage ratio comes into play.
But what, exactly, is it? We’ll go over all that and more, so keep reading!
What Is the Interest Coverage Ratio?
The interest coverage ratio measures how easily a company can use its earnings to pay off its debt.
Specifically, the interest coverage ratio (ICR) tells you how many times over your earnings can pay off the current interest on your debt. So, if you have an ICR of 3.5, that means you can pay off your interest 3.5 times over.
This ratio can also be considered a debt or profit ratio or the times interest earned (TIE) ratio, which we’ll dive into later on.
How Is the Interest Coverage Ratio Used in Business?
The interest coverage ratio can give you a quick view of your company’s financial health by telling you how easy it would be to pay off your debt.
It can also help lenders decide how much of a loan you should get.
Potential investors or lenders (such as banks) use this ratio to assess the risks of giving you a loan. Essentially, they want to know how well you can handle your existing payments and outstanding debt before giving you money.
To see how it all works, let’s look at how to calculate your interest coverage ratio.
How Do You Calculate Interest Coverage Ratio?
You can calculate the interest coverage ratio by dividing your company’s earnings before interest and taxes (EBIT) by your interest expense.
Interest Coverage Ratio = EBIT / Interest Expense
Where EBIT can be calculated as:
EBIT = Net Income + Interest + Taxes
You can find net income on your profit and loss statement. Interest and taxes are are listed as expenses on your profit and loss statement.
Interest Coverage Ratio Calculator
You can find net income on your profit and loss statement. Interest and taxes are listed as liabilities on your balance sheet.
While this sounds simple, how do you actually use this formula? Let’s find out via an example.
Interest Coverage Ratio Example
Say you own a construction company and have the following financial information.
- Net income: $48,000
- Tax expense: $12,000
- Interest expense: $40,000
Since we need EBIT in the interest coverage ratio formula, let’s calculate that first.
EBIT = Net Income + Taxes + Interest
EBIT = $48,000 + $12,000 + $40,000 = $100,000
Then, plug the calculated EBIT into the interest coverage ratio formula.
Interest Coverage Ratio = $100,000 / $40,000 = 2.5
For the construction company, you have an interest coverage ratio of 2.5.
But what exactly does that mean?
How To Interpret Interest Coverage Ratio
The interest coverage ratio tells you the number of times your earnings can cover your interest obligations.
In the example, your earnings before interest and taxes can pay for the company’s interest expenses 2.5 times over.
In other words, you have enough earnings (before interest and taxes) to pay off the interest on your loans 2.5 times. This is why it’s also referred to as the times interest earned ratio.
What Does a Higher Ratio Mean?
The higher the ratio, the easier it is for you to pay off your current debts. For instance, if you had a ratio of 5, it would mean your EBIT is enough to cover your interest payments 5 times over.
That tells lenders that you have money to put towards growing your business–whether it’s hiring more employees, making more products, or investing in research.
What Does a Lower Ratio Mean?
A lower ratio means your existing debt is a bigger burden on your company. Specifically, it tells you (and potential lenders) that most of your earnings are going towards debt payments instead of growth.
What Is a Good Interest Coverage Ratio?
Generally, 1.5 is the minimum interest coverage ratio a company should maintain. But many investors would prefer even less risk than that. Typically, lenders and investors want to see an interest coverage ratio of 2 or higher.
Think of it like your credit score. Lenders often require a minimum credit score for small business loans—usually around 600.
Keep In Mind…
…that earnings vary widely between industries. So these benchmarks might help, but they aren’t the end all be all. For instance, utility companies have relatively stable revenue streams and cash flows. In contrast, earnings for restaurants and retail businesses are subject to changes in the market for a given period.
It’s best to only look at companies in your industry. That way, you’re comparing apples to apples and can see if you really need to improve.
Variations on the Interest Coverage Ratio
There’s no single metric that’s going to tell you everything about the financial condition of your business.
When comparing your company’s earnings to its debt, it’s helpful to consider different financial ratios that let you make more liberal or conservative estimates.
There are two common variations of the interest coverage ratio. They’re based on different versions of your earnings.
Ratio Using EBITDA
The first variation of your company’s interest coverage ratio uses earnings before interest, taxes, depreciation, and amortization (EBITDA) instead of EBIT. EBITDA is also known as operating income or operating profit.
Depreciation and amortization are bookkeeping methods businesses use to spread out the cost of long-term assets. Depreciation spreads out the cost of a physical (tangible) asset over time, while amortization does the same for intangible assets (like patents).
For instance, say you buy an excavator for your construction company. It costs $100,000 and has a useful life of 5 years.
Instead of expensing the entire $100,000 up front, you account for the expenses over time. In this case, you can depreciate $20,000 yearly for 5 years.
By using depreciation, you factor in the expense of your long-term assets every year they’re used, which gives you a more accurate picture of the costs of running your business.
If you want to find your depreciation and amortization amounts, they’ll be listed on your income statement under expenses.
How To Calculate Interest Coverage Ratio Using EBITDA
First, we need EBITDA, which is calculated via:
EBITDA = Net income + Interest + Taxes + Depreciation + Amortization
Then, we can calculate the interest coverage ratio by:
Interest Coverage Ratio (using EBITDA) = EBITDA / Interest Expense
Let’s add the $20,000 depreciation expense for the excavator to the previous financials:
- Net income: $48,000
- Taxes: $12,000
- Interest: $40,000
- Depreciation: $20,000
- Amortization: $0
Then, plug these numbers into the above formulas:
EBITDA = $48,000 + $12,000 + $40,000 + $20,000 = $120,000
Interest Coverage Ratio (using EBITDA) = $120,000 / $40,000 = 3.0
Since EBITDA adds depreciation and amortization back to the initial EBIT, you get a larger number in the numerator and a higher interest coverage ratio of 3.0 (instead of 2.5).
Ratio Using EBIAT
The other variation uses earnings before interest after taxes (EBIAT), and it’s more conservative. This ratio tells you how easily you can pay off your company’s debt obligations after you’ve paid your taxes.
You can calculate earnings before interest after taxes using the following formula:
EBIAT = Net income + Interest Expense
When you plug EBIAT into the ratio and use the numbers from the previous example, you get:
EBIAT = $48,000 + $40,000 = $88,000
Interest Coverage Ratio (using EBIAT) = EBIAT / Interest Expense
Interest Coverage Ratio (using EBIAT) = $88,000 / $40,000 = 2.2
This ratio of 2.2 is lower than the first calculation of 2.5, but it’s still in a good range—above 2. It means that after you’ve paid off taxes, you still have enough earnings to cover your debt payments 2.2 times over.
Compared to the other two debt ratios, this one will most likely give you the smallest ratio number.
Assessing Your Finances Using Interest Coverage Ratio
Debt is a necessary part of starting and running most businesses. Just make sure you’re making enough money to pay off your loans and continue investing in business growth.
Your interest coverage ratio can indicate your company’s ability to pay off the interest on your loans. But you’re not the only one who might use this information.
Potential lenders or investors can use the interest coverage ratio when deciding whether to give you new lines of credit. The higher the ratio, the better because it means you have enough money to pay for your current loans comfortably.
Now that you know how the ratio works, grab those financial statements and see where you stand.
1. Introducing Yourself
Your introductory email needs to pack a lot of information into a small package. Try something like this:
Sample
Text Copied to Clipboard
Copy

Hello Jane,
My name is John Doe and I work for ABC Agency, where we provide business insurance policies to many of Dallas' rockstar small businesses.
Congratulations on your new business, Jane's Bakery. Are you wondering if you have all the insurance you need? Or if your policies will really cover you in a pinch?
At ABC Agency, we pride ourselves on providing robust, comprehensive coverage options to companies like yours with flexible, pay-as-you-go plans.
Are you available this week to talk more about how we can help? I can help you find the most affordable rates and the best policies out there.
I look forward to speaking with you soon.
Cheers,
John Doe
2. Presenting a Quote
Once you've met with your potential client, a quick reply with their quote will get the ball rolling.
Sample
Text Copied to Clipboard
Copy

Hi Jane,
Thanks so much for meeting with me this morning. I loved touring Jane's Bakery–I can still smell those delicious chocolate chip cookies baking! You have a great location, and I'm sure you're going to do great on Front St.
After reviewing my notes, I've pulled together an insurance quote for you (attached). I recommend a business owner's policy. A BOP includes several insurance products in one: liability, property insurance, and business interruption insurance. It offers robust coverage at a competitive price.
I'll call you in a few days to see what you think about this insurance plan. In the meantime, if you have any questions, don't hesitate to email me or call me at [phone number].
Again, thank you for your time today. I look forward to working with you in the future.
Cheers,
John Doe
3. Thanks for Purchasing a Policy
Gratitude is important! It's never a bad idea to thank your clients for their business.
Sample
Text Copied to Clipboard
Copy

Hi Jane,
Thank you for choosing a business owner's policy with ABC Agency. We know it's so important to get the right coverage for your business, and we are honoured you've placed your trust in us.
We're excited to work closely with you, and our no. 1 goal is to make sure you're business is always protected.
Do you have any questions? We are here to help. Reach out whenever something comes to mind.
Thank you again for choosing ABC Agency to insure Jane's Bakery.
Cheers,
John Doe
4. Welcome Email
A welcome email helps clients feel like you're there to help–and can softly pitch other insurance products you offer.
Sample
Text Copied to Clipboard
Copy

Dear Jane,
Welcome to the ABC family! We are thrilled to have you as a new customer and can't wait to meet all of your insurance needs.
As an independent insurance agency, we work with multiple insurance providers to find the best coverage options for all our customers. If you need any other type of insurance–like [include additional offerings unique to your agency, like life insurance, health insurance, home insurance or anything else]–we can help you too.
Do you want to discuss any of these policies?
Cheers,
John Doe
5. Introducing a New Product
A happy client may want to expand their business with you.
Sample
Text Copied to Clipboard
Copy

Hello Jane,
I hope all is well with you and Jane's Bakery. I stopped in yesterday for a blueberry muffin and coffee, and they were delicious. I loved the hint of cinnamon in the muffin! Was that your idea?
I wanted you to be the first to know we are now offering commercial vehicle insurance to our policyholders. Auto insurance for your catering vans is super important since your personal car insurance won't cover them.
We're offering this insurance coverage solely to our current business clients at the moment and have some very competitive rates.
Would you like me to work up a quote for you?
As always, thanks so much for being a part of the ABC family.
Cheers,
John Doe
6. Asking For Referrals
Once your relationship is established and comfortable, let your clients help you grow.
Sample
Text Copied to Clipboard
Copy

Hi Jane,
You've been a valuable member of the ABC family for two years now, and we so appreciate your business–not to mention the muffins you supply for our monthly meetings!
Because you are a valued policyholder, I wanted to ask a quick favour. I know you are active in the local Chamber of Commerce, and I'm hoping you might know some colleagues who would benefit from working with our insurance company.
Referrals are one of the most effective ways to connect with our community since people really trust their friends, family and colleagues. Is there anyone you'd recommend I speak with?
Remember that in addition to business insurance products, we offer everything from life insurance policies to pet insurance.
As a thank you for your help, we will send you an Amazon gift card of $100 when your referrals buy insurance from us.
Thanks so much for your help!
Cheers,
John Doe
7. Policy Renewal
If your client needs to renew their policy with you, send an email like this:
Sample
Text Copied to Clipboard
Copy

Hi Jane,
I hope you're doing well! What a year it's been—from being listed as one of the top 5 bakeries in Dallas to being an official vendor for the city—you have so much to be proud of.
Just a heads up that your business owner's policy is up for renewal soon and will expire on June 15, 2023.
If you're still happy with the coverage, we can easily renew it for you.
Do you have some time to chat this week?
Looking forward to serving you again!
Cheers,
John Doe