Any one of a range of financial statistics used to assess a company’s capacity to meet its financial obligations is referred to as a coverage ratio.
Greater ability of the corporation to satisfy its financial obligations is indicated by a higher ratio, whilst decreased ability is indicated by a lower ratio. Lenders and creditors frequently utilize coverage ratios to assess a potential borrower’s financial status.
In general, coverage ratio is a metric used to assess a company’s capacity to pay off debt and fulfil other financial commitments like dividends and interest payments.
The interest coverage ratio, debt service coverage ratio, and asset coverage ratio are examples of common coverage ratios.
The most typical coverage ratios are:
- The ability of a business to pay its debt’s interest costs alone (interest coverage ratio)
- Debt service coverage ratio: A company’s capacity to settle all debt commitments, including principal and interest payments
- The ability of a corporation to cover interest costs with its cash balance is known as the cash coverage ratio.
- The ability of a corporation to pay back its debt commitments with its assets is known as the asset coverage ratio.
When comparing a company to its rivals, coverage ratios are also helpful. It is crucial to evaluate organizations that are comparable to one another because a coverage ratio that is considered acceptable in one area could be viewed as dangerous in another.
While comparing the coverage ratios of businesses within the same industry or sector can clarify how they compare financially, doing so across businesses in various industries or sectors is less beneficial because it may be like comparing apples to oranges.