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Struggling to keep up with your business debt payments? Whether it’s a line of credit, equipment loan, or any kind of borrowing, there’s one crucial number you need to watch: your interest coverage ratio.
What is the interest coverage ratio?
The interest coverage ratio tells you how easily your business can pay the interest on its debts using its operating earnings. It’s one of the cleanest ways to measure financial health, especially if you’re managing loans (for business acquisitions etc.), credit lines, or other forms of financing.
The formula is simple:
Interest Coverage Ratio = EBIT ÷ Interest Expense
- EBIT stands for Earnings Before Interest and Taxes. It’s the operating profit that your business makes from its core activities before you factor in debts or taxes.
- Interest Expense is what the words tell you: the interest you’re paying on loans or financing.
What’s a “healthy” ratio?
For most small to mid-sized businesses:
- An EBIT ratio above 2 is considered solid which means you’re in good shape.
- Between 1 and 2 is tight, manageable, but should be monitored.
- Below 1 means you’re not earning enough to cover your interest costs. That’s a warning sign that needs immediate attention.
We’ll get into how to improve the number later. For now, just know this: the higher your ratio, the more flexibility and credibility your business has with lenders, partners, and even your team.
How to calculate interest coverage ratio without fancy tools
You don’t need a CFO or an advanced financial model to figure out your interest coverage ratio. If you’ve got basic access to your financials, even through QuickBooks, Xero, or Excel, you can calculate it in a few steps.
Step 1: Find your EBIT
For most accounting tools, it is labelled as “operating income”. You can also calculate it manually:
EBIT = Revenue – Operating Expenses (excluding interest and taxes)
So, if your business made you $500,000 and your total operating expenses (excluding loan interest and taxes) were $400,000, your EBIT is $100,000.
Step 2: Find your interest expense
This should be listed clearly on your income statement or under “expenses” in your chart of accounts. It includes interest paid on loans, lines of credit, equipment financing, and basically, any borrowing costs that aren’t principal payments.
Step 3: Do the math
Use the formula to do the math. Suppose your
- EBIT = $120,000
- Interest = $30,000
- Interest Coverage Ratio = 4.0
That means your operating income can cover your interest payments four times over, which is a good position to be in.
When to calculate it
We recommend tracking this:
- Quarterly, to watch trends
- Annually, for year-end health checks or lending applications
- Anytime you take on new debt, to assess your repayment capacity
You don’t need a dashboard to start; it’s just consistent tracking. And once you have the number, interpreting it is the next key step.
How to interpret the ratio and spot warning signs
Knowing your interest coverage ratio is useful. But what really matters is how you interpret it, and whether it signals financial strength, risk, or a need to make changes.
Here’s how to read the ratio:
The ratio is less than 1.0, a red alert
It means your operating earnings aren’t enough to cover your interest payments. You’re either dipping into savings or relying on new debt to stay afloat.
If this continues, lenders may see you as high risk, you may struggle to get approved for future loans, or it could lead to default or emergency cash decisions.
Action: Rework your expenses or consider refinancing them immediately. This is not a sustainable position.
Ratio between 1.0 and 2.0, tight but manageable
You’re generating enough profit to cover your interest, but there’s not a lot of cushion. One slow quarter or unexpected expense could tip the balance. It also means you’re likely paying a lot in interest relative to your profits, which might restrain you from investing further to grow or handle downturns.
Action: Watch cash flow closely, look for ways to reduce debt costs, and increase profitability where possible.
A ratio above 2.0 is comfortable and healthy
Most businesses want to be in this bracket where they have plenty of room to spare and are seen as trustworthy parties for credit. A ratio above 2 makes it highly likely for lenders to offer better terms, and you also have room to invest, grow, or handle short-term downfalls.
Action: Keep tracking it quarterly and continue optimizing your operating margin.
Trends matter more
You don’t just calculate your interest coverage ratio once and forget about it. You need to pay attention to the following:
- Is your ratio improving over time? That’s a good sign of increasing efficiency or reducing debt burden.
- Is it deteriorating over time? That’s a warning, even if it’s still above 2.0.
- Is it volatile? Inconsistent profitability or irregular debt payments might be affecting your stability.
You don’t only need to be just above 2.0 but require it to increase over time.
Actionable ways to improve your interest coverage ratio
If your ICR (interest coverage ratio) is too low or unstable, it’s a sign your business may be carrying too much financial risk. But you don’t need to overhaul everything to fix it. Just focus on a few high-leverage changes. Here’s how to do it:
Increase your EBIT by focusing on profitable operations
One of the fastest ways to strengthen your ICR is to improve your operating profit or EBIT. That doesn’t always mean selling more, but having a smooth, more profitable operation. Start by looking at your current costs and find out if there are any unnecessary tools, subscriptions, or overheads that you could eliminate.
Also, assess your product or service mix. Prioritize high-margin offerings over low-return work. Even small price adjustments or process efficiencies can significantly improve EBIT without needing to grow top-line revenue. Remember: this ratio rewards smart operations, not just more sales.
Reduce interest expenses with smarter debt management
You can also improve your ratio by lowering the amount of interest you’re paying. If you’re holding high-interest loans, refinancing or consolidating that debt could significantly reduce your monthly obligations. This is especially relevant if your credit profile has improved or rates have dropped since you first took out the loan.
Paying off the most expensive debt first, especially if it’s variable-rate or short-term, can create quick wins. Moving from multiple small credit facilities to a structured repayment loan may also offer lower blended interest rates. Be careful not to take on new financing unless it directly improves operational output or reduces cost elsewhere.
Smooth cash flow with automation and strategic timing
Even with a solid EBIT and a manageable debt, poor timing between inflows and outflows of cash can taint your interest coverage. That’s where cash flow consistency is of utmost importance. Tools like Forwardly help automate both accounts payable and accounts receivable, ensuring you’re never caught off guard by a payment you can’t cover or a receivable that didn’t come in on time.
You can also negotiate longer payment terms with businesses whenever possible, like Net 45 or Net 60 instead of Net 30. By tightening up your receivables window to Net 15 – 30, you can create a buffer around when cash comes in and goes out, so you’re always in a better position to meet your interest obligations.
Rethink capital allocation and debt use
It’s worth reassessing how you’re using capital in your business. Debt should fund strategic growth or essential infrastructure, not serve as a patch for poor cash flow planning. Before taking on new financing, ask whether the return justifies the cost. If it doesn’t increase EBIT, it could end up hurting your ratio rather than helping it.
Cut or delay non-essential CapEx (capital expenditures) and avoid spending on things that don’t drive operational efficiency or revenue expansion. Capital discipline is one of the most overlooked drivers of a healthy interest coverage ratio, and it’s completely within your control.
How to track interest coverage ratio like a CFO
Tracking your interest coverage ratio isn’t a once-a-year finance task; it should be part of your regular financial review. You don’t need to be a CFO or have one on staff. What you do need is a simple system for calculating, reviewing, and acting on numbers.
Use tools that surface key metrics automatically
The first step is making sure your accounting software or financial dashboard gives you visibility into both EBIT and interest expense. Most platforms like QuickBooks, Xero, or your bookkeeping reports already have this data; you just need to know where to look.
Set up a custom dashboard or monthly report that highlights:
- Operating income (EBIT)
- Total interest paid (across loans, LOCs, or financing)
- Current interest coverage ratio
- Debt repayment schedules and upcoming payment dates
Set a cadence for review
For most small to mid-sized businesses, tracking your interest coverage ratio quarterly is a good starting point. If you’re actively managing debt or planning for expansion, review monthly.
Put a recurring reminder on your calendar to run the calculation, update your dashboard, and compare the ratio against the previous period. The goal isn’t just to track the number; it’s to spot trends early.
Visibility is the real advantage
The interest coverage ratio is one of the most overlooked indicators that can quietly tell you whether your business is stable, over-leveraged, or in a strong position to grow.
You don’t need a CFO to stay on top of your cash, debt, and performance.
With Forwardly, you can automate accounts payable and receivable and get real-time insights into your cash position.
Start now and streamline your cash flow for free with Forwardly.
