How to Calculate the Fixed Charge Coverage Ratio

How to calculate the fixed charge coverage ratio, step by step

The fixed charge coverage ratio is the earnings available for the bills that must be paid, divided by those bills. Fixed charges are the bills a company must pay whether it sells anything or not — interest on its loans and the lease payments on its buildings and equipment. The ratio asks how many times the company’s earnings cover those must-pay bills, and it is the number a lender checks before lending.

The formula is simple: fixed charge coverage ratio = (EBIT + lease payments) ÷ (interest expense + lease payments). EBIT is earnings before interest and tax — interest is one of the charges being covered, so it must not be subtracted first — and lease payments are added back to the top because a lease is a fixed charge too: the earnings must cover the lease as well as the interest. The fixed charges are interest expense plus lease payments, and the earnings before fixed charges are EBIT plus lease payments. On $240,000 of EBIT, $30,000 of interest and $30,000 of lease payments, the fixed charges are $60,000.00 and the earnings before fixed charges are $270,000.00, so the ratio is $270,000.00 ÷ $60,000.00 = 4.50.

The worked example, line by line. Step 1 — the fixed charges: $30,000 + $30,000 = $60,000.00. Step 2 — the earnings before fixed charges: $240,000 + $30,000 = $270,000.00. Step 3 — the ratio: $270,000.00 ÷ $60,000.00 = 4.50. Step 4 — the interest-only coverage: $240,000 ÷ $30,000 = 8.00 — higher than the fixed charge coverage ratio, because it ignores the lease payments. Step 5 — the EBIT needed for a 3.00 ratio: 3.00 × $60,000.00 − $30,000.00 = $150,000.00. Step 6 — the interest allowed for a 3.00 ratio: $270,000.00 ÷ 3.00 − $30,000.00 = $60,000.00. Step 7 — the lease allowed for a 3.00 ratio: ($240,000.00 − 3.00 × $30,000.00) ÷ (3.00 − 1) = $75,000.00. Work it yourself in the fixed charge coverage ratio calculator.

What the number means

A 4.50 fixed charge coverage ratio means the earnings cover the fixed charges four and a half times over — the company earns $270,000 before fixed charges against $60,000 of fixed charges, so it has $210,000 of slack after paying them. A ratio below 1.00 means the earnings do not cover the fixed charges at all — the company must dip into cash, sell assets, or borrow to pay bills it cannot avoid. A ratio of 1.00 means the earnings exactly cover the fixed charges — one bad month and the company is short. Lenders generally look for a ratio of 1.25 or higher before lending — below that the margin is too thin for comfort — and a ratio above 2.00 is comfortable for most businesses. A ratio of 4.50 is very comfortable.

Fixed charge coverage vs interest coverage, debt service coverage and the current ratio

The fixed charge coverage ratio and interest coverage are different things: interest coverage divides EBIT by interest only, and ignores lease payments — a company with heavy leases can look safe on interest coverage and still be stretched once the leases are counted. Work out interest coverage on its own in the interest coverage ratio calculator, or read the guide to interest coverage.

Debt service coverage is different again: it is a cash view, operating cash flow against principal plus interest, while fixed charge coverage is an earnings view that counts leases but not principal repayments. Work it out in the debt service coverage ratio calculator, or read the guide to debt service coverage. The current ratio is different again: it is a snapshot of short-term assets against short-term debts, while fixed charge coverage is a flow — how much the business earns against the bills that keep coming.

The snapshot caveat: what the ratio assumes

The fixed charge coverage ratio is a snapshot, not a forecast. The model assumes the lease payments and interest stay the same for the year — but real companies refinance, sign new leases and pay down loans, so the fixed charges move. A ratio of 4.50 today can fall fast if the company signs a big new lease or borrows more. Use the ratio to see where the company stands now, then check whether the charges are rising or falling.

Traps to avoid

First, the edges. If interest and lease payments are both zero, the fixed charges are zero and the ratio is undefined — division by zero, there are no fixed charges to cover — and the calculator shows “undefined” with a note, never a number. If EBIT is negative — the company is losing money before interest — the ratio goes negative: it earns nothing toward its fixed charges, so the calculator shows the negative figure with a note, never hides it. And if EBIT is zero, only the lease payments count toward the top, so the ratio is a fraction of one.

Second, the rounding. The ratio is displayed to two decimals, half-up. A ratio that displays as the target can sit just below it unrounded, so always print the unrounded figure when the boundary matters.

Third, a high ratio from almost no fixed charges. A company with almost no debt and no leases has a high ratio because it has almost no fixed charges — the ratio says nothing about whether it is growing or earning well. And a low ratio is not automatically fatal: a young company investing heavily can carry a low ratio for a while, as long as the earnings are rising toward the charges. Read the ratio alongside the cash and the growth, not alone.

Frequently asked questions