How do you calculate the cash coverage ratio?
The short answer
Cash coverage ratio = (EBIT + depreciation and amortisation) ÷ interest expense, both over the same period. EBIT plus depreciation and amortisation is EBITDA, so it is usually worked as EBITDA ÷ interest.
It shows how many times the cash a business's operations produce, before charges that cost no cash this period, covers the interest it owes. Lenders read it beside the interest coverage ratio, which uses EBIT alone.
Every figure shown here is invented for illustration. Nothing on this page is computed from anyone’s accounts.
A freight company paying $80,000 of interest covers it 7.5 times
An invented freight company with a fleet of trucks, over the twelve months to June:
| Twelve months to June | $ |
|---|---|
| Operating profit (EBIT) | 432,000 |
| Depreciation and amortisation | 168,000 |
| EBITDA | 600,000 |
| Interest expense | 80,000 |
Cash coverage ratio = (432,000 + 168,000) ÷ 80,000 = 7.5 times
Interest coverage ratio = 432,000 ÷ 80,000 = 5.4 times
The gap between the two is depreciation. Trucks wear out, which costs money over the years, but not in cash this year, and it is this year's cash that pays this year's interest.
Cash coverage, interest coverage and debt service coverage answer different questions
| Ratio | Formula | Answers |
|---|---|---|
| Interest coverage (times interest earned) | EBIT ÷ interest | Does operating profit, after depreciation, cover the interest? |
| Cash coverage | (EBIT + depreciation and amortisation) ÷ interest | Does the cash operations produce cover the interest? |
| Debt service coverage (DSCR) | Cash available for debt service ÷ the interest and principal due | Can the business meet every repayment, not only the interest? |
Banks write covenants on all three, each defined in the facility agreement. When a covenant is tested, the agreement's definition wins over any textbook's.
Use twelve months, or the year to date, never one month
One month's EBITDA swings with the season and with when invoices were raised, and interest on some loans is charged quarterly. A single month's ratio jumps for both reasons at once. Lenders usually test on the last twelve months; for a board, the year to date works too, as long as both halves of the ratio cover the same months.
Interest means the cost of borrowing, and nothing else
Include:
- interest on loans, overdrafts, asset finance and hire purchase;
- the interest part of lease payments, where leases are on the balance sheet, as under IFRS 16. Those leases move both halves: the interest joins finance costs and the depreciation of the leased asset is added back.
Leave out:
- bank charges and card fees, which are operating costs;
- repayments of the loan itself, which are debt service, not interest;
- interest received, unless the facility agreement nets it off. Say which you did.
Read it against the covenant first, then against its own trend
| Cash coverage | What it usually means |
|---|---|
| Below 1 | Operations did not pay the interest; the gap came from cash or more borrowing |
| 1 to 2 | Thin: one bad quarter can mean a missed payment or a broken covenant |
| Comfortably above the covenant | Room to absorb a bad quarter, so watch the trend instead |
A ratio that falls from six to three in a year matters more than where it sits today. Read it with net burn where the business is not yet profitable.
Four ways the cash coverage ratio misleads
- Interest booked when it is paid. A loan charged quarterly puts three months of interest into one month. Accrue it monthly.
- EBITDA read as cash. A business growing fast ties cash up in debtors and stock: EBITDA can cover the interest several times while the bank balance falls. Read it with the cash flow statement.
- Other income counted in. Interest received or a one-off gain lifts EBIT. Some definitions include other income and some do not; pick one and keep to it.
- A loss quoted as a ratio. When EBITDA is negative the ratio is negative too, and says only that operations paid none of the interest. Quote the loss.
EBITDA and finance costs come built in; the ratio is one request away
Magic MIS keeps EBITDA, depreciation and finance costs on lines of their own for every month, from the trial balance. The ratio is in its KPI library as interest cover, worked as EBITDA ÷ finance costs, which is the cash coverage ratio as defined here; other income stays out of it, because the engine's EBITDA leaves other income out. Added to the board through the chat, it is from then on worked out by the engine each month like every other figure, and its box says how. A company whose books hold no finance costs sees it greyed out, because there is nothing to cover.
What people ask about the cash coverage ratio
Is the cash coverage ratio the same as EBITDA interest cover?
Yes. EBIT plus depreciation and amortisation is EBITDA, so both are EBITDA ÷ interest. Lenders also call it EBITDA cover or simply interest cover; the facility agreement's definition is the one that counts.
What is a good cash coverage ratio?
Lenders commonly look for two to three times or more, and the covenant in the facility agreement sets the real floor. Compare with the business's own trend as well as with the floor.
Why is cash coverage higher than interest coverage?
Because it adds back depreciation and amortisation, which are costs with no payment this period. The gap is widest in businesses with a lot of equipment, vehicles or property.
Does the cash coverage ratio include loan repayments?
No. It covers interest only. The debt service coverage ratio adds the principal due, which is what a lender asks about before a new loan.
Read next
- How is EBITDA calculated in an MIS report?Revenue less direct costs, employee costs and other operating expenses, with other income kept below it. A worked example from EBITDA down to profit before tax.Read
- How do you calculate operating margin?Operating margin = operating profit ÷ revenue × 100, after depreciation and before interest and tax. The formula, a worked example, and how it differs from EBITDA margin.Read
- How do you calculate net burn?Net burn is the cash a business used in the month, with financing taken out. The formula, gross burn beside it, a worked example, and where the figures come from.Read
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