## What is the fixed cost coverage rate?

The Fixed Charge Coverage Ratio (FCCR) measures a company’s ability to cover its fixed costs, such as debt repayments, interest charges and equipment rental charges. It shows how well a company’s profits can cover its fixed expenses. Banks often look at this ratio when evaluating whether to lend money to a business.

Key points to remember

- The Fixed Charge Coverage Ratio (FCCR) shows the extent to which a company’s earnings can be used to cover its fixed charges such as rent, utilities, and debt payment.
- Lenders often use the fixed charge coverage ratio to assess a company’s overall creditworthiness.
- A high FCCR result indicates that a company can adequately cover fixed charges based on its current earnings alone.

Fixed charge coverage rate

## The fixed charge coverage ratio formula is as follows:

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=

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B

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F

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B

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where:

E

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earnings before interest and taxes

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fixed charges excluding taxes

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interest

\begin{aligned} &FCCR = \frac{EBIT + FCBT}{FCBT + i} \\ &\textbf{where:}\\ &EBIT=\text{earnings before interest and taxes}\\ &FCBT=\text{fixed charges before tax}\\ &i=\text{interest}\\ \end{aligned}

FVSVSR=FVSBJ+IEBIJ+FVSBJwhere:EBIJ=earnings before interest and taxesFVSBJ=fixed charges excluding taxesI=interest

## How to Calculate the Fixed Charge Coverage Ratio

The calculation to determine a company’s ability to cover its fixed costs begins with earnings before interest and taxes (EBIT) from the company’s income statement, then adds back interest expense, rental expense, and other fixed charges.

Then the adjusted EBIT is divided by the amount of fixed charges plus interest. A ratio result of 1.5, for example, shows that a company can pay its fixed charges and interest 1.5 times on its profits.

## What does the fixed charge coverage ratio tell you?

The fixed charge ratio is used by lenders looking to analyze how much cash flow a business has to pay off its debt. A low ratio often reveals a lack of ability to make payments on fixed charges, a scenario that lenders try to avoid because it increases the risk that they will not be repaid.

To avoid this risk, many lenders use coverage ratios, including the ratio multiplied by interest earned (ETR) and fixed charge coverage ratio, to determine a company’s ability to take on debt and take on more debt. A business that can cover its fixed costs at a faster rate than its peers is not only more efficient but also more profitable. It is a company that wants to borrow to finance its growth rather than to get through a difficult period.

A company’s sales and the costs related to its sales and operations constitute the information on its income statement. Some costs are variable costs and depend on the volume of sales over a given period. As sales increase, variable costs also increase. The other costs are fixed and must be paid whether or not the company has an activity. These fixed costs can include things like equipment lease payments, insurance payments, installments on existing debt, and preferred dividend payments.

## Example of a fixed charge coverage ratio in use

The purpose of calculating the fixed charge coverage ratio is to see how well revenues can cover fixed charges. This ratio is very similar to the TIE ratio, but it is a more conservative measure, taking into account additional fixed charges, including rental charges.

The fixed charge coverage rate is slightly different from the TIE, even if the same interpretation can be retained. The fixed charge coverage rate adds the rents earnings before income and taxes (EBIT) then divides by the total interest and lease charges.

Let’s say Company A has EBIT of $300,000, lease payments of $200,000, and $50,000 in interest expense. The calculation is $300,000 plus $200,000 divided by $50,000 plus $200,000, or $500,000 divided by $250,000, or a fixed charge coverage ratio of 2x.

The company’s revenue is twice its fixed costs, which are considered low. This is because the company could only pay the fixed charges twice with the income it has available, which increases the risk that it will not be able to make future payments. The higher this ratio, the better.

Like the TIE, the higher the FCCR ratio, the better.

## Fixed cost coverage ratio limits

The FCCR does not take into account rapid changes in the amount of capital for new and growing businesses. The formula also does not take into account the effects of funds taken from profits to pay an owner’s drawdown or pay dividends to investors. These events affect the ratio inputs and can give a misleading conclusion unless other parameters are also considered.

This is why when banks assess the value of a company solvency for a loan, they typically look at several other benchmarks in addition to the fixed charge coverage ratio to get a more complete view of the company’s financial condition.

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