What is the importance of the term “Interest Coverage Ratio” of a firm in India?
- 1. It helps in understanding the present risk of a firm that a bank is going to give loan to.
- 2. It helps in evaluating the emerging risk of a firm that a bank is going to give loan to.
- 3. The higher a borrowing firm’s level of Interest Coverage Ratio, the worse is its ability to service its debt.
Select the correct answer using the code given below:
1 and 2 only
2 only
1 and 3 only
1, 2 and 3
Answer is Right!
Answer is Wrong!
This question was previously asked in
UPSC IAS – 2020
Statement 1 is correct: A company’s current Interest Coverage Ratio indicates how many times its current earnings can cover its current interest obligations. A low ratio signals potential difficulty in meeting interest payments (present risk), while a high ratio indicates a strong ability to do so.
Statement 2 is correct: By analyzing historical trends of the ratio, future projections of EBIT, and changes in interest expenses, a lender can evaluate the likelihood of the firm being able to service debt in the future, thus helping assess emerging risk.
Statement 3 is incorrect: A *higher* Interest Coverage Ratio means the company has more earnings available relative to its interest expense. This indicates a *better* ability to service its debt obligations, not worse. A *lower* ratio suggests a worse ability.