Also known as Times Interest Earned, this is the ratio of Operating Income for the most recent year divided by the Total Non-Operating Interest Expense, Net for the same period.
If Total Interest Expense, Net for the period is less or equal 0 (i.e. the equivalent of Interest Income), then we set Interest Coverage to a value of 100x - this is somewhat arbitrary but it ensures that these companies will also pass a high interest coverage screen.
If a company is loss-making, we still calculate this ratio - the figure will therefore be negative.
NOTE: This item is not meaningful for Banks and Insurance companies.
You can read more about it here in the FAQ Centre.
This is a useful way of measuring a company's ability to meet its debt obligations. When the interest coverage ratio is smaller than 1, the company is not generating enough profit from its operations to meet its interest obligations.
The Company would then likely have to either use cash on hand to make up the difference or borrow funds. It is seen as a possible warning sign when interest coverage falls below 2.5x.
N.B. This relatively simple definition implicitly assumes that operating income is a true proxy for cashflow from operations which it should be for a steady state business where depreciation is equal to capex, and working capital change is zero.