The Fixed Charge Coverage Ratio (FCCR) is a financial metric that evaluates a company’s capacity to pay its fixed costs that do not fluctuate with production or sales. These fixed charges typically include interest payments on debt, lease payments for property or equipment, and other mandatory financial commitments.
Lenders and business owners use FCCR to assess financial stability. A strong FCCR signals a company can easily meet its fixed obligations, reducing the risk of default. Conversely, an FCCR below 1.0 means the company’s earnings aren’t sufficient to cover these essential expenses, indicating potential financial distress.
How To Calculate FCCR
The most common formula is:
FCCR = (EBIT + Fixed Charges Before Tax) / (Fixed Charges Before Tax + Interest Payments)
Where:
- EBIT (Earnings Before Interest and Taxes) is a measure of operating profit before financing and tax expenses.
- Fixed Charges Before Tax often include lease expenses and other fixed obligations aside from interest.
- Interest Payments refer to interest expenses on debt.
This formula quantifies how many times a company’s earnings cover its fixed payment commitments.
Example:
Suppose Brenda’s Brilliant Bikes has an EBIT of $150,000, lease payments of $30,000, and interest payments of $20,000.
Calculate:
- Numerator (cash available): $150,000 + $30,000 = $180,000
- Denominator (bills to pay): $30,000 + $20,000 = $50,000
- FCCR = $180,000 / $50,000 = 3.6
An FCCR of 3.6 indicates the company earns 3.6 times its fixed charges, a strong position often viewed positively by lenders.
Interpreting FCCR Values:
- Below 1.0: Insufficient earnings to cover fixed charges; high risk.
- 1.0 to 1.25: Barely covering fixed costs; caution advised.
- Above 1.25: Generally considered healthy; lenders often want at least this much.
Related Ratios:
- The Times Interest Earned (TIE) Ratio only considers interest payments, making FCCR broader.
- The Debt Service Coverage Ratio (DSCR) often also includes principal repayments for loans.
Important Considerations:
- Industry benchmarks matter; capital-intensive industries tolerate lower FCCRs than service sectors.
- FCCR should be reviewed alongside cash flow and overall debt metrics for a full financial picture.
- Adjusting EBIT for non-cash expenses like depreciation can provide a more accurate view of cash availability.
For business owners and lenders, the Fixed Charge Coverage Ratio is an essential tool for evaluating ongoing financial obligations and making informed lending or management decisions.
For more on business financial ratios, see our Cash Flow Coverage Ratio article.
Sources:
- Investopedia: Fixed-Charge Coverage Ratio (https://www.investopedia.com/terms/f/fixed-charge-coverage-ratio.asp)
- Corporate Finance Institute: Fixed Charge Coverage Ratio (https://corporatefinanceinstitute.com/resources/knowledge/finance/fixed-charge-coverage-ratio/)
- IRS for tax references and financial definitions (https://www.irs.gov/)