Fixed Charge Coverage Ratio (FCCR)
What is Fixed Charge Coverage Ratio? Definition
The fixed charge coverage ratio is the financial ratio which is used to measure the ability of the firm to pay all the fixed charge and expenses with its income before the interest and taxes.
This is the expanded version of the time interest earned ratio.
Fixed charge coverage ratio formula calculated by dividing the sum of EBIT and fixed charge before taxes by the sum of fixed charge before taxes and interest.
The fixed charge coverage ratio = (EBIT + Fixed charges before tax)/(Fixed charges before tax + Interest)
In this formula, any number of fixed cost can be used because this ratio is not limited to only 1 cost.
Analyst and investors use this ratio to find the ability of the firm to make its fixed asset. The result of this ratio is in the number instead of percentage just like time interest ratio. From this ratio, we can measure that how many time before the interest and taxes payment a firm can pay its fixed cost from its income.
This ratio work as a solvency ratio because it also measures how easily a company can pay its due bills. If the company can not pay its bills it means that the company is not in the position to make the profit and it is in the loss.
A high ratio indicates that the company is less risky and healthier. For the investment, it is a healthier company.
There is an instrument retailer shop which manufactures and repair harps. For the remodelling of the store, the loan requires. For the loan, the bank calculates the fixed charge coverage ratio.
According to the income statement, this shop had $300,000 of income before interest and tax and interest income is 30,000 dollars. His least current payment for 1 month is 2,000 dollars which are 24,000 dollars for 1 year. Fixed charge coverage ratio can be calculated as
6 times= ( 300,000 + 24,000)/(24,000 + 30,000)
From the above result, we know that the income of retailer shop is 6 times greater than the interest and lease payment of this shop. The ratio of this shop is higher because of which he can get a loan easily from the bank.
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