What is the importance of the term Interest Coverage Ratio
What is the importance of the term "Interest Coverage Ratio" of a firm in India?
- It helps in understanding the present risk of a firm that a bank is going to give loan to.
- It helps in evaluating the emerging risk of a firm that a bank is going to give loan to.
- 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 only
- 2 only
- 1 and 3 only
- 1, 2 and 3
Answer: A
Explanation
One of the significant and most crucial liquidity ratios is the Interest Coverage Ratio, which indicates the level of a company's ability to afford the interest that is to be paid by the company for raising debt. It does not measure the ability to make principal payments on the debt; instead it depicts how much the company can afford to pay the interests on the debt promptly.
- The interest coverage ratio is used to see how well a firm can pay the interest on outstanding debt. So, statement 1 is correct.
- Also called the times-interest-earned ratio, this ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm. So, statement 2 is correct.
- A higher coverage ratio is better, although the ideal ratio may vary by industry. So, statement 3 is not correct.
- Exam Year: 2020