Coverage Ratios - Business Finance - ثاني ثانوي

3.10 Coverage Ratios Key Term Times-interest-earned Link to digital lesson www.sen.ardu.sa Coverage ratios indicate the ability of the firm to service (to "cover") interest or dividend payments. All coverage ratios consider the funds available to meet a particular expense relative to that expense. The most common is timas-interest-named, which measures the ability of the firm to meet its interest obligations. That ratio is: Times interest earned Earnings before interest and taxes Annual Interest charges A ratio of 2 indicates that the firm has SAR 2 in operating income for every SAR 1 in interest expense. The numerator uses operating income (EBIT), since interest is paid after other expenses but before taxes. The higher the numerical value of the ratio, the safer should be the interest payment. For Daana's, the times-interest-earned ratio is: Time Ratio of operating income (EBIT) to interest expense, measure of the safety of a debt instrument SAR 1,500,000 = 4.41 SAR 340,000 This indicates that Daana's has operating income of SAR 4.41 for every SAR I in interest expense, which suggests that the firm should easily meet its interest obligations. You Try It Abdullah's industrial service has earnings before interest and taxes of SAR 89,200,000 and annual interest charges of SAR 17,940,000 Calculate the ames-interest-earned. وزارة التعليم CHAPTER Analysis of Financial Statements 119

120Business Finance Exercises Choose the correct answer. 1. Coverage ratios indicate the ability of the firm to service (to "cover") interest or dividend payments. True/False 2. A times interest-earned ratio of 3.5 indicates: a. the firm has operating income of SAR 3.5 for every SAR 1 in interest expense. b. the firm has operating expenses of SAR 35 for every SAR 1 in interest expense. c. the firm has operating income of SAR 35 for every SAR 1 in interest expense. d. the firm has operating expenses of SAR 35 for every SAR 1 in interest expense.