The measurement of a company’s ability to pay its financial obligations (debt).
In very simple terms, a higher coverage ratio implies that a company is more likely to meet its financial obligations. While a lower coverage ratio implies that a company is at risk of not meeting their financial obligation and therefore at risk of bankruptcy.
Let me give you an example in relation to your personal finances
Lets assume Michael is paid on a monthly basis. On payday, Michael receives a $2000 check from his company.
Michael has the following monthly debts:
- Mortgage: $800
- Car: $300
- Student Loan: $200
- Credit Card: $100
- Grand Total: $1400
Michael’s coverage ratio is going to be 1.4x ($2000 paycheck / Total Debt Payments)
Now let’s take a look at an example of an actual company
In 2012 Microsoft (MSFT) had Operating Income of $21.7 Billion and Interest Expense of $380 million.
Therefore, their coverage ratio is going 57x ($21.7 Billion Income / $380 Million Interest)