INTM578010 - Thin capitalisation: interest cover

Definition of interest cover

A company’s (or group’s) interest cover is a measure of its ability to service its debt. It is common to look at it in two ways: the ratio of the accounts profits before interest and tax to the interest payable and the ratio of the available cash to the interest payable. For example, if the profit before interest (payable or receivable) and tax as shown by the accounts is £12m and the interest payable is £4m, the interest cover on a profits basis is 3:1. If non-cash items in the accounts total £2m in debits, the interest cover on a cash basis is 3.5:1.

These definitions presuppose that there is a single way of calculating the accounts profits for thin capitalisation purposes, and this is not the case – see INTM578030 onwards.

The term ‘income cover’ is often encountered, and is sometimes regarded as interchangeable with ‘interest cover’. However, the latter is more commonly used to refer to the cash position and the former to accounts profits.

The more important of the two measures is the cash-flow position – a lender is primarily interested in the ability of a borrower to service debt, and cash flow measures are not distorted by accounting policies. Where a group does not prepare a consolidated cash-flow position, for example if it is part of a larger group, then interest cover may be considered based on the operating profit shown by the profit & loss account. In such a case, however, it is important to have a good understanding of the accounting policies used. See, for example, a consideration of the effect of Financial Reporting Standard 17 in INTM585000 onwards.