The fixed charge coverage ratio (FCCR) is a financial ratio that measures how well a company can cover its fixed expenses, such as interest payments, lease payments, and debt repayments, with its operating income. It is a type of solvency ratio that shows the ability of a company to meet its long-term obligations and avoid default or bankruptcy.
The FCCR is calculated by dividing the earnings before interest and taxes (EBIT) plus the fixed charges before tax by the fixed charges before tax plus the interest expense. The formula is as follows:
where:
- EBIT = earnings before interest and taxes
- FCBT = fixed charges before tax
- i = interest expense
The fixed charges before tax may include lease payments, rent, insurance, utilities, and other recurring expenses that are not affected by the level of sales or production. The interest expense is the amount of interest paid on the outstanding debt of the company.
The FCCR indicates how many times the company can pay its fixed charges with its operating income. A higher FCCR means that the company has more cash flow available to cover its fixed expenses and reduce its debt. A lower FCCR means that the company is struggling to generate enough income to pay its fixed charges and may face liquidity problems or insolvency.
Lenders and creditors often use the FCCR to assess the creditworthiness and risk of default of a potential or existing borrower. A minimum FCCR may be set as a covenant in a loan agreement to ensure that the borrower maintains a certain level of solvency and does not overextend its debt. Typically, a FCCR of 1.5 or higher is considered satisfactory, while a FCCR of less than 1 is considered risky.
Fixed Charge Coverage Ratio in Excel
To calculate the FCCR in Excel, you need to have the following data:
- EBIT: You can find this on the income statement of the company or calculate it by subtracting the operating expenses from the operating revenue.
- FCBT: You can estimate this by adding up the fixed charges that the company pays before tax, such as lease payments, rent, insurance, utilities, etc. You may need to refer to the notes or disclosures in the financial statements or annual reports of the company to find this information.
- i: You can find this on the income statement of the company or calculate it by multiplying the average interest rate by the average debt balance.
Once you have the data, you can use the following formula in Excel to calculate the FCCR:
= (EBIT + FCBT) / (FCBT + i)
For example, suppose a company has the following data:
- EBIT: $100,000
- FCBT: $20,000
- i: $10,000
The FCCR can be calculated as:
= ($100,000 + $20,000) / ($20,000 + $10,000)
= 4
This means that the company can cover its fixed charges four times with its operating income.
Fixed Charge Coverage Ratio: An Example
To illustrate the FCCR with a detailed example, let us consider the following scenario:
- A company wants to borrow $500,000 from a bank to expand its business.
- The bank requires the company to maintain a minimum FCCR of 1.5 as a loan covenant.
- The company has the following data for the last year:
| Item | Amount |
|---|---|
| Operating revenue | $1,000,000 |
| Operating expenses | $600,000 |
| Interest expense | $50,000 |
| Lease payments | $100,000 |
| Rent | $50,000 |
| Insurance | $10,000 |
| Utilities | $10,000 |
To calculate the FCCR of the company, we need to first calculate the EBIT and the FCBT. The EBIT is the operating revenue minus the operating expenses, which is:
$1,000,000 - $600,000 = $400,000
The FCBT is the sum of the lease payments, rent, insurance, and utilities, which is:
$100,000 + $50,000 + $10,000 + $10,000 = $170,000
The FCCR is then the EBIT plus the FCBT divided by the FCBT plus the interest expense, which is:
= ($400,000 + $170,000) / ($170,000 + $50,000)
= 2.28
This means that the company can cover its fixed charges 2.28 times with its operating income. Since this is higher than the minimum FCCR of 1.5 required by the bank, the company meets the loan covenant and can borrow the money.
Fixed Charge Coverage Ratio: Other Approaches
There are some variations and alternatives to the FCCR that may be used by different analysts or lenders. For example, some may use the earnings before interest, tax, depreciation, and amortization (EBITDA) instead of the EBIT as the numerator, as it is a more comprehensive measure of cash flow. Some may also include other fixed charges, such as preferred dividends, sinking fund payments, or maintenance capital expenditures, in the denominator, as they are also obligations that the company has to meet.
The choice of the FCCR formula depends on the purpose and preference of the user, as well as the availability and reliability of the data. However, it is important to be consistent and transparent when using the FCCR, and to compare it with other relevant ratios, such as the debt-to-equity ratio, the current ratio, or the interest coverage ratio, to get a more complete picture of the solvency and financial health of the company.
