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Interest Coverage Ratio - Explained in Hindi | #39 Master Investor - YouTube
Channel: Asset Yogi
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Namaskar, my name is Mukul and you are welcome to the Asset Yogi
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In this video, we are going to discuss one more important solvency ratio
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which is the interest coverage ratio
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See, when any business or any company
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takes loan for doing their business
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Then it is very natural that it has to pay interest every year.
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And anyone will pay interest only when
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he will earn profit some times more than interest
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This means if in a year you have to pay 10 lakhs as interest
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Then the person has to earn at least 40 lakhs or 50 lakhs in a year
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Then only he would be able to pay the interest comfortably. So we will know this
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thing by interest coverage ratio.
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How comfortably a company can pay its interest
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So this video is also a part of the series in which we are discussing solvency ratios.
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Earlier we covered debt ratios. In which we discussed debt to capital ratio,
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debt to asset ratio,
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and debt to equity ratio
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If you haven't watched this video then please watch them.
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You'll find the links in the description.
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In this video, we will see the formula of interest coverage ratio.
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We will understand the calculations
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and we will also see how its interpretation is done
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With that, I will show you a live demonstration.
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We will see how the interest coverage ratio of any company is calculated online
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So please watch the video till the end.
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Let's go straight towards the blackboard.
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Music
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First, we will try to understand what exactly is the interest coverage ratio.
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And where is it used?
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Whenever a company goes to take a loan from the bank
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Then the bank see if the company
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can make their debt payment easily or not.
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In debt,
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the first is the interest payment
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and the other one is principal payment.
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By interest coverage ratio, we will understand that if a company can
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make their interest payments easily or not.
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And if we want to know about the total debt payment
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Then for that, we calculate the debt service coverage ratio.
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We will cover this in our next video.
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In this video, we will understand the interest coverage ratio.
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So first we saw the angle of the bank.
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What is the use of the second point?
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When there's any fund that is analyzing any company and thinking about investing in it.
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So the fund manager will also calculate the interest coverage ratio.
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He would want to know whether this company can pay its debt easily or not.
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So what can we know by interest coverage ratio?
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Whatever the annual interest payments of the company are
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How many times does the company earn?
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This means operating profit is how many times of interest payment
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We want to know that. This is the formula of simple ratio
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Divide operating profit by interest payment.
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How many times does the company earn you'll know that.
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So operating profit is
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earnings before interest and taxes
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You will divide interest payment by this.
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Sometimes we may see one more variation in the formula
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Some analysts and some bank uses EBITDA
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They add depreciation and amortization
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They add them because they say that depreciation and amortization are not a real cash outflow
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This money is in the company, these are only adjustments
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At least this money is available for debt services
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So in that case when they consider EBITDA
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Then the ICR in that case is slightly more.
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And it is less in this case. So in this case when the ICR is slightly more
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Then the sanctioned limit of the loan amount can be more
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That's all.
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So this is quite a conservative ratio
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And this one is a bit liberal ratio.
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But whatever formula you will use whether you are doing analysis
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of any company or the bank is analyzing what loan amount to provide
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The formula should be used consistently.
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Even if you are comparing companies, then also use the same formula
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That's more important. Let's calculate it by taking an example.
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Assume earnings before interests and taxes of any company
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is 400 crores.
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And we will assume the annual interest payment is 100 crores.
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So we will use this formula
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ICR =400 crores/ 100 crores
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Then it is earning 4 times.
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So the interest is covered easily.
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4 is quite a comfortable ratio.
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See, sometimes what happens is maybe EBIT is not available directly to you.
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You may have profit after tax
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So what you can do is add the tax portion
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And with that add the interest portion.
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So you will get EBIT.
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Or if you are using EBITDA
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Then add depreciation to this, add amortization amount.
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So you will get EBITDA. But if you see the balance sheet of a company
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Then you will get all the information most of the time. So this was about calculation
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Now we will see that this value is 4, is it sufficient?
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Or is it insufficient? What is the ideal ratio?
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The banks and analysts generally prefer
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the ratio should be more than 3.
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That means a company can make its debt payments quite easily.
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But in some cases, it is considered between 2 and 3.
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Less than 2 is not considered by banks and analysts
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So, 2 to 3 is considered sometimes
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If there are some companies whose cash flows are quite stable
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For example power companies
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or infrastructure companies whose contracts are for 20 to 30 years
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So their cash flow is guaranteed in a way.
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So in these cases, your interest coverage ratio
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can be considered between 2 to 3.
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But higher the ICR
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the better it will be
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That means the solvency of the company is better.
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There are no chances for it to go bankrupt.
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We will understand that.
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It can do its debt service easily. What is the second benefit of having a good
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interest coverage ratio? Whenever a company takes money from the bank
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This means it borrows or takes out a loan. Then they get quite competitive interest rates
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And the terms of loans are also better.
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So I think you got the concept of interest coverage ratio.
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Now we will quickly see the online calculation. We will take an example of a company.
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So see, I have found the financials of Reliance Industries.
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We have gone to the India Infolines website.
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And we are seeing a profit and loss statement here. This is a consolidated statement
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And we will see the figures for March 2018. Let's go down. So what do we want?
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We have to calculate EBIT. As you can see, EBIT is not given directly.
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The profit before tax is given here.
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And with that, we will know the interest expense.
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So if we have to find out EBIT then we will add interest expenses to profit before tax.
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If we calculate EBIT then what will be the EBIT
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This is our profit before tax
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So, 49426.
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How much will I add to this?
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I will add the interest expenses, 8052
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The figure will be 57478
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Now what we have to calculate
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We have to calculate the interest coverage ratio.
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Now, we will divide EBIT by interest. So what will it be?
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57478/8052(interest)
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We will do 8052.
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So what will be our interest coverage ratio?
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It will be approx 7.1
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As you can see it is quite comfortable.
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We said more than 3 is comfortable
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So 7.1 is quite a comfortable ratio.
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And see you don't have to calculate it by yourself.
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You can see it in the ratios
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Let's see it by going to the ratios.
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If we come down then you will get it in the leverage ratio
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See here, we have calculated 7.1. It is exactly the same.
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So on this website of India Infoline
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We put the formula of EBIT/interest
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They don't use EBITDA. This can vary.
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Different websites can use different formulas.
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But whatever website you are seeing, either see the same website
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or whatever formula you are using use the same formula consistently
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So see, we have covered an interest coverage ratio in this video.
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The other remaining ratios. I have covered many ratios in this video.
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And I will cover other ratios in the coming videos.
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So please watch those videos of mine.
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And if you haven't watched the old videos of ratios then please watch them
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Because you will know the total financial health of any company only when
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you analyze all the ratios. So that's all in this video.
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Actually, I enjoyed making this video a lot.
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So if you liked this video then like and share the video.
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If you have any suggestions or you want to suggest any topics for future videos
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Or if you want to share any other thoughts with the community then please comment below.
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So let's meet in the next video
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Till then keep learning, keep earning, and be happy
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