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Home Accounting Ratios Analysis/Financial Ratios Analysis Debt Service Ratio or Interest Coverage Ratio
 
 

Debt Service Ratio or Interest Coverage Ratio:

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Definition:

The ratio measures debts servicing capacity of a business so far as interest on long-term loans is concerned. This ratio shows how many times the interest charges are covered by the earnings. Debt service ratios is also know as interest coverage ratio.

Formula:

The ratio is calculated with following formula:

Debt service ratio = Earnings before interest and taxes (EBIT) / Fixed interest charges

Example:

From the following, calculate interest coverage ratio.

  $
9% Mortgage loan 10,00,000
7.5% Debentures 12,00,000
Net profit (after tax) 9,72,000
Income tax rate 50 %

Solution:

Interest coverage ratio = Earnings before interest and tax / Fixed interest charges

= 21,24,000* / 1,80,000**

11.8 times

Working:

(i) Calculation of Interest Payable:

(l0,00,000 9 / 100 ) + (12,00,00 15 / 2 1 / 100)

90,000 + 90,000

= $1,80,000**

(ii) Calculation of Tax Liability:

Tax rate = 50%

Profit after tax = 972,000

Tax amount = [9,72,000 / (100 - 50)] x 50

= 9,72,000

(iii) Profit before Interests and Tax:

= Profit after tax + Tax + Interest

= 9,72,000 + 9,72,000 + 1,80,000

= 21,24,000*

Comments:

Net profits available for payment of interest are approximately 12 times. It implies that even if earnings decline to 1/11th of the current figure long-term creditors interest repayments is safe.

More study material from this to
 

More study material from this topic:

Meanings, Nature and Usefulness of Ratios Analysis
Interpretation of Ratios
Important Factors for Understanding Ratios Analysis
Significance and Usefulness Ratios Analysis
Classification of Ratios
Analysis of Short Term Financial Position or Test of Liquidity
Current Ratio
Quick/Acid Test/Liquid Ratio
Absolute Liquid Ratio
Inventory/Stock Turnover Ratio
Debtors / Receivable Turnover Ratio
Creditors / Payables Turnover Ratio
Working Capital Turnover Ratio
Profitability Ratios
Gross Profit Ratio (GP Ratio)
Operating Profit Ratio
Net profit ratio (NP ratio)
Earnings Per Share Ratio
Operating ratio
Expense ratio
Solvency ratios - Test of Long Term Solvency
Debt-equity Ratio
Debt Service Ratio or Interest Coverage Ratio
Fixed Assets Ratio
Debts to Total Funds or Solvency Ratio
Reserves to Capital Ratio
Capital Gearing Ratio
Proprietary Ratio
Accounting Ratios Formulas
Limitations of Ratios Analysis

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
 ----------------------------------------------------------------------------
  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
----------------------------------------------------------------------------
  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
----------------------------------------------------------------------------
  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
----------------------------------------------------------------------------
  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
----------------------------------------------------------------------------
  Activity Based Costing System
----------------------------------------------------------------------------
  Standard Costing and Variance Analysis
----------------------------------------------------------------------------
  Balanced Scorecard
----------------------------------------------------------------------------
  Capital Investment Analysis/Capital Budgeting
 

 

 

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