INTM578040 - Thin capitalisation: interest cover

What is the correct measure of income?

As described in INTM578010, both interest cover (measuring cash flow) and income cover (measuring profit cover and the sustainability of a business) can be used as a measure of a company’s ability to service its debts. It is often useful to run both measures in a thin capitalisation case.

There are a number of ways of modifying the accounts profits of a group or company in order to arrive at a measure of its ability to service its interest bearing debt. The two most common are:

• Earnings Before Interest and Tax (EBIT)
• Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA)

In both cases ‘earnings’ is the same as the accounts bottom-line profits. EBIT is dealt with in INTM578050 and EBITDA from INTM578060. The term Profits is sometimes used in this context rather than Earnings, producing PBIT and PBITDA, but the two terms are synonymous.