when repaying a bank loan or buying a bond The company must not only pay the principal. but also have to pay the predetermined interest rate Therefore, the company’s ability to pay such interest rates is one of the key factors investors must consider. especially bond investors
The company’s ability to pay the interest rate on these loans is measured by a matrix known as Interest coverage ratio (ICR), also known as Multiply the interest earned (TIE) in many other literature. See how this metric can influence investment decisions below.
Understanding the Interest Coverage Ratio
Interest Coverage Ratio is the income and expense ratio of the company’s interest rate. This ratio is used to determine a company’s financial ability to pay interest rates on its debt.
The way to find this ratio is to divide the company’s earnings before interest and taxes (EBIT) and interest expenses. The higher the ratio between income and interest, the better. The financial position of the company will improve.
No one ICR value is suitable for every industry. Each industry must have different ICR standards. It depends on the level of trend of companies in the industry to use loans as a source of funding. Industries with a high tendency to take out loans also tend to have high interest rates.
Therefore, you should not analyze ICR for a single company. but also compared to other companies’ ICR values. operating in the same branch So you know what the average ICR value for the industry is.
Interest Coverage Ratio (ICR) Formula
The ICR formula is ICR = EBIT / Interest Expense.
EBIT : profit before interest and taxes or gross income before interest and taxes.
interest expenses : All expenses the company has to pay back to the loan fund provider.
In some cases, analysts use EBITDA As an element in calculating this matrix, EBITDA or Income before interest, taxes, depreciation and amortization These are income before interest, taxes, depreciation and amortization.
Example of how to calculate interest coverage ratio
It is well known that PT Maju Mundur Cantik is a beauty product manufacturing company. In the income statement, the company recorded EBIT of Rs.135,000,000 plus interest expense of Rs.2,500,000 per month.
So, the company’s ICR value is:
ICR = EBIT / Interest Expense = IDR 135,000,000/(Rs.2,500,000 x 12) = 4.5 which means that PT Maju Mundur Cantik is capable of paying 4.5 times interest.
Information about income and expenses, including EBIT and interest expenses. It is contained in the company’s income statement. So you don’t have to calculate manually using sales data.
Here is a sample data matrix for the Indonesian energy industry.
|Interest Coverage Ratio
|PT Medco Energi Internasional Tbk
|PT Delta Dunia Makmur Tbk
|PT TBS Energi Utama Tbk
|PTT Indika Energy Tbk
|PT Samindo Resources Tbk
|PT Adaro Energy Indonesia Tbk
|PT Bukit Asam Tbk
|PT Energi Mega Persada Tbk
|PT Indo Tambangraya Megah Tb
|PT Harum Energy Tbk
According to the sample data provided by Finbox.com, the average ICR for the Indonesian energy industry until 2022 is 0.8x, meaning that companies with higher ICR values (as written below) are relatively able to pay higher interest rates compared to other companies with higher ICR values. industry average
Using the Interest Coverage Ratio (ICR)
1. To assess the financial health of the company
The interest coverage ratio is one of the key indicators used to assess a company’s financial profile. current ratioThis is because every third party loan whether it is a bank or a bond investor There must be interest that the company must pay along with the principal debt.
The interest rate on this loan is usually only about 10% of the primary loan. This means that the company’s finances can be said to be in bad shape if the company is unable to pay interest on the loan (ICR < 1). In the long run, it means that the company will have trouble paying its debts.
2. To assess the risks of investment/lending
This matrix is widely used by rating agencies to determine the quality of bonds or letters of credit issued by companies.
The better the company’s ICR value, the better. Opportunities that banks or other parties The more willing to give credit, the more. This is an indirect indication that the company’s financial position is good.
What is a good interest coverage ratio value?
A low ICR (below 1) is bad because it means that the company’s earnings are insufficient to pay interest. work Therefore, there is a possibility that the company’s business operations will be less than reasonable.
Many experts argue that a company is financially sound if its ICR value is greater than 2 or 3, which means the company’s EBIT value is at least 2 or 3 times greater than its interest expense.
Again, however, the ICR value of each company in different industries will definitely be different Therefore, investors must first determine the industry’s ICR benchmark. Additionally, a company’s ICR value can also vary from year to year depending on the needs of the company. Therefore, investors are asked to analyze the company’s ICR value in several accounting periods. round at once