Fixed-Charge Coverage Ratio

Fixed-Charge Coverage Ratio
See also


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) [1]. It is an ability to satisfy all of fixed financial costs, more precisely - fixed charges [2].

FCCR is more advanced version of another ratio - Times Interest Earned Ratio (TIE) [3]. 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 [4]. 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 [5]. 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 [6].

Fixed-Charge Coverage Ratio Formula

The formula is [7]:

\(FCCR = \frac{EBIT + FCBT}{FCBT + I}\)

Where:

  • 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 solution\[FCCR = \frac{$1,000,000 + $200,000}{$200,000 + $100,000} = 4\]

The ratio presents that company's earnings before interest and taxes can cover fixed charges 4 times [8].

Interpretation of Fixed-Charge Coverage Ratio

Fixed-Charge Coverage Ratio enable to carry out the coverage test. The higher the ratio, the better for investors and creditors. The lower the ratio, the more risky and unstable company is [9].

Footnotes

  1. Besley S., Brigham E.F. 2009, p. 239
  2. Peterson P.P., Fabozzi F.J. 1999, p. 94
  3. Beenhakker H.L. 1996, p. 16
  4. Fridson M.S. 2018, Chapter 1
  5. Besley S., Brigham E.F. 2009, p. 238-239
  6. Block R.L. 2012, p. 197
  7. Qatar Financial Centre 2015
  8. Peterson P.P., Fabozzi F.J. 1999, p. 95
  9. Gadge A., Deora B., Kasture R. 2013, p. 224

References

Author: Oksana Szłapowska