Here is Question No. 62 a part of our series on UPSC Prelims 2020.
Q62. What is the importance of the term “Interest Coverage Ratio” of a firm in India?
It helps in understanding the present risk of a firm that a bank is going to give a loan to.
It helps in evaluating the emerging risk of a firm that a bank is going to give loan to.
The higher a borrowing firm’s level of Interest Coverage Ratio, the worse is its ability to service its debt.
Select the correct answer using the code given below: (a) 1 and 2 only (b) 2 only (c) 1 and 3 only (d) 1, 2 and 3
Answer: A
Interest Coverage Ratio is an indicator of a company’s ability to pay interest out of its current earnings. It is expressed as the number of times that the interest can be covered from its current earnings.
Statement 1 is correct: It can help in understanding the present risk, as a firm with a low-interest coverage ratio just may not have enough earnings in order to meet the annual interest obligations.
Statement 2 is correct: ICR is commonly used by lenders, creditors, and investors to determine the company’s riskiness relative to its current debt or for future borrowing.
Statement 3 is not correct: The higher the interest coverage ratio the better. The lower the ratio, the more the company is burdened by debt expense. When a company’s interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.
