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How is debt-service ability measured?

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Any ratio that measures a firm’s ability to meet its debt obligations out of earnings is a coverage ratio.  The higher the ratio, the greater the ability of the firm to meet its debt expenses.  The main coverage ratios are:

  • Times-interest-earned (TIE) ratio – Measures a firm’s ability to satisfy its borrowing costs from operations:

EBIT/Interest Expense
or
EBITDA/Interest Expense

EBIT/Debt Service
or
EBITDA/Debt Service

  • Fixed charge coverage ratio (times fixed financial charges covered) – Indicates how many times a firm is able to meet all of its fixed charges (i.e., contractually committed periodic interest and principal payments on funded debt as well as on leases) out of earnings before interest and taxes (EBIT) or earnings before interest, taxes, depreciation and amortization (EBITDA):

(EBIT + Fixed Charges)/Fixed Charges
or
(EBITDA + Fixed Charges)/Fixed Charges

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