Interest Coverage Ratio
The Interest Coverage Ratio measures how many times a company's operating earnings can cover its interest expense, indicating its ability to service debt obligations from its current earnings.
Calculated as EBIT divided by interest expense, the interest coverage ratio is a fundamental solvency metric. A ratio of 3x means the company earns three times as much from operations as it needs to pay in interest — implying a comfortable buffer. A ratio below 1.5x raises serious concerns; below 1x means the company cannot cover interest from operations alone, and must rely on asset sales, additional borrowing, or equity issuance.
In India's infrastructure sector, interest coverage has been a recurring source of stress. Power distribution companies (DISCOMs), road concessionaires, and port operators often carry enormous project-level debt incurred during the construction phase, before revenues ramp up. Several power generation companies that bid aggressively for coal linkages and PPAs (power purchase agreements) in the 2010s later found their interest coverage ratios deteriorating to below 1x as coal prices rose and electricity tariffs remained regulated. This contributed to the large infrastructure NPA problem that weighed on Indian banks.
Credit rating agencies in India — CRISIL, ICRA, CARE Ratings — heavily weight the interest coverage ratio when assigning ratings to corporate bonds and commercial paper. A company with an interest coverage ratio falling below 2x typically sees its rating come under pressure, which increases its borrowing costs and can trigger a self-reinforcing cycle of financial distress.
Retail investors often overlook capitalised interest — where a company under construction capitalises interest as part of the cost of the asset being built (as permitted under Ind AS 23). This treatment removes the interest from the income statement during the construction period, artificially inflating EBIT and therefore the interest coverage ratio. Once the asset is commissioned and interest is no longer capitalised, the ratio can drop sharply.
Tracking interest coverage alongside the trend in absolute interest expense is important. A company whose revenues and EBIT are growing but whose interest expense is growing faster is a business where debt is accumulating quicker than profitability — a deteriorating trajectory that the ratio alone would not flag unless examined over multiple years.