Which ratio measures the ability to service interest from operating income?

Which ratio measures the ability to service interest from operating income?

• A. Loan-to-Value (LTV)
• B. Drawdown
• C. Interest Coverage Ratio (ICR)
• D. Acceleration

Answer: (C)

The Interest Coverage Ratio (ICR) is a significant financial metric that measures a company's ability to pay interest on its outstanding debt using its operating income. The ratio is calculated by dividing the operating income (or earnings before interest and taxes, EBIT) by the interest expenses. A higher ICR indicates that the company earns significantly more than it pays in interest, demonstrating a solid capacity to meet interest obligations. This ratio is critical for lenders and investors as it provides insight into the risk level of a company’s financial practices. If the ICR is low, it may indicate potential difficulties in servicing debt, making the entity appear riskier to investors and creditors. In contrast, the other options do not serve the same purpose. Loan-to-Value (LTV) assesses the ratio of a loan to the value of an asset purchased, which is more about collateral and financing structure. Drawdown refers to the reduction of available funds under a loan agreement, and Acceleration is a contractual right for creditors to demand immediate payment under certain conditions, rather than assessing the ongoing capacity to manage interest payments. These options do not focus on the relationship between operational income and interest obligations, making them less relevant for this specific measure of financial health.

The Interest Coverage Ratio (ICR) is a significant financial metric that measures a company's ability to pay interest on its outstanding debt using its operating income. The ratio is calculated by dividing the operating income (or earnings before interest and taxes, EBIT) by the interest expenses. A higher ICR indicates that the company earns significantly more than it pays in interest, demonstrating a solid capacity to meet interest obligations.

This ratio is critical for lenders and investors as it provides insight into the risk level of a company’s financial practices. If the ICR is low, it may indicate potential difficulties in servicing debt, making the entity appear riskier to investors and creditors.

In contrast, the other options do not serve the same purpose. Loan-to-Value (LTV) assesses the ratio of a loan to the value of an asset purchased, which is more about collateral and financing structure. Drawdown refers to the reduction of available funds under a loan agreement, and Acceleration is a contractual right for creditors to demand immediate payment under certain conditions, rather than assessing the ongoing capacity to manage interest payments. These options do not focus on the relationship between operational income and interest obligations, making them less relevant for this specific measure of financial health.