Fixed-Charge Coverage Ratio
Fixed-Charge Coverage Ratio - is defined as financial ratio, also known as FCCR. FCCR determines company's long-term ability to pay all of its fixed charges from the income generated before any fixed financing charges are considered (earnings before interest and taxes + lease payments) . It is an ability to satisfy all of fixed financial costs, more precisely - fixed charges .
FCCR is more advanced version of another ratio - Times Interest Earned Ratio (TIE) . Fixed-Charge Coverage Ratio represents the ratio of fixed charges to some degree of cash flow. Fixed charges can be defined as covering dividends and interests expense . A ratio is calculated by dividing earnings which are available to cover all fixed charges by all fixed charges. Fixed charges include: long-term lease obligations (lease payments), insurance payments, sinking funds payments and preferred dividend payments . In particular by using ratios like Fixed-Charge Coverage Ratio, the company can avoid any difficulties of assessing leverage during worse period and for example fluctuating property values .
Fixed-Charge Coverage Ratio Formula
The formula is :
- FCCR - Fixed-Charge Coverage Ratio
- EBIT - Earnings Before Interest and Taxes
- FCBT - Fixed Charge Before Tax
- I - Interest
Example of calculation Fixed-Charge Coverage Ratio
Company X has $1,000,000 of income before interest and taxes and $100,000 of interest expense. The enterprise also bears the costs of lease payments - $200,000.
The ratio presents that company's earnings before interest and taxes can cover fixed charges 4 times .
Interpretation of Fixed-Charge Coverage Ratio
Advantages of Fixed-Charge Coverage Ratio
Fixed-Charge Coverage Ratio is a useful tool for assessing a company’s ability to pay its fixed obligations. It provides a simple calculation that allows lenders and investors to quickly assess the financial health of a company. The following are some of the advantages of the fixed-charge coverage ratio:
- It provides a quick and easy way to measure a company’s ability to pay its fixed expenses.
- It gives lenders and investors a useful benchmark to assess a company’s financial health.
- It takes into account both operating income and any lease payments made by the company.
- It provides a measure of the company’s ability to meet its current obligations while still accumulating additional capital.
- It is an easily understandable measure of a company’s financial health that can be used by all stakeholders.
Limitations of Fixed-Charge Coverage Ratio
The Fixed-Charge Coverage Ratio (FCCR) is a financial ratio used to measure a company's ability to pay its fixed charges from its income. Although it is a useful tool in analyzing a company's financial health, there are several key limitations to consider when using this ratio. These limitations include:
- The ratio does not take into account the company's cash flows which can be an important factor in assessing a company's financial stability.
- The ratio does not consider the company's total debt obligations, only the fixed financing charges, which may not give an accurate picture of a company's financial health.
- The ratio is subject to manipulation and does not account for non-cash items such as depreciation and amortization expenses.
- The ratio does not consider other important factors such as the company's working capital and the quality of its assets.
- The ratio is backward-looking, so it does not provide any insight into a company's future financial health.
- Operating Income Coverage Ratio (OICR): This ratio measures the ability of a company to cover its fixed charges with operating income. It is calculated by dividing operating income by total fixed charges.
- Cash Flow Coverage Ratio (CFCR): This ratio measures the ability of a company to cover its fixed charges with cash flow. It is calculated by dividing cash flow from operations by total fixed charges.
- Debt Service Coverage Ratio (DSCR): This ratio measures the ability of a company to cover its fixed charges with debt service payments. It is calculated by dividing total debt service payments by total fixed charges.
In summary, Fixed-Charge Coverage Ratio is a financial ratio used to measure the ability of a company to cover its fixed charges with income generated before any fixed financing charges are considered. Other approaches related to Fixed-Charge Coverage Ratio include Operating Income Coverage Ratio, Cash Flow Coverage Ratio, and Debt Service Coverage Ratio.
- Besley S., Brigham E.F. 2009, p. 239
- Peterson P.P., Fabozzi F.J. 1999, p. 94
- Beenhakker H.L. 1996, p. 16
- Fridson M.S. 2018, Chapter 1
- Besley S., Brigham E.F. 2009, p. 238-239
- Block R.L. 2012, p. 197
- Qatar Financial Centre 2015
- Peterson P.P., Fabozzi F.J. 1999, p. 95
- Gadge A., Deora B., Kasture R. 2013, p. 224
|Fixed-Charge Coverage Ratio — recommended articles|
|Debt to total assets ratio — Solvency ratios — Debt service coverage — Ebitda ratio — Capitalization ratios — Capitalization ratio — Cash Flow-to-Debt Ratio — Coverage ratio — Asset coverage ratio|
- Beenhakker H.L. (1996), Investment Decision Making in the Private and Public Sectors, Quorum Books
- Besley S., Brigham E.F. (2009), Principles of Finance, Cengage Learning
- Block R.L. (2012), Investing in REITs: Real Estate Investment Trusts, John Wiley & Sons
- Fridson M.S. (2018), Foundations of High-Yield Analysis, CFA Institute Research Foundation
- Gadge A., Deora B., Kasture R. (2013), Certified Credit Research Analyst (CCRA) Level 1, Taxmann
- Peterson P.P., Fabozzi F.J. (1999), Analysis of Financial Statements, John Wiley & Sons
- Qatar Financial Centre (2015), QFINANCE: The Ultimate Resource, Bloomsbury
Author: Oksana Szłapowska