INTM578050 - Thin capitalisation: interest cover
Earnings Before Interest and Tax - EBIT
The EBIT formula is a modification of the net profits to produce
a measure of the ability of a company to service its debts.
Consider the following profit & loss account:
| 2002 | 2001 | ||
| £m | £m | ||
| Turnover | 61.556 | 49.542 | |
| Cost of sales | 15.768 | 13.568 | |
| Gross profit | 45.788 | 35.974 | |
| Administrative expenses | 20.786 | 17.459 | |
| Operating profit | 25.002 | 18.515 | |
| Interest receivable | 1.314 | 1.220 | |
| Interest payable | 7.642 | 7.543 | |
| Profit on ordinary activities before taxation | 18.674 | 12.192 | |
| Tax on profit on ordinary activities | 3.921 | 2.682 | |
| Operating profit for the financial year | 14.753 | 9.510 |
Starting from the operating profit for the financial year,
and assuming that there are no elements in the cost of sales or
administrative expenses that require special attention, the values
of EBIT can quickly be calculated:
| 2002: | EBIT = | 14.753 + 7.642 + 3.921 – 1.314 | = £25.002m | |
| Interest cover = | 25.002/7.642 | = 3.27:1 | ||
| 2001: | EBIT = | 9.510 + 7.543 + 2.682 – 1.220 | = £18.515m | |
| Interest cover = | 18.515/7.543 | = £2.46:1 |
Note that both interest payable and interest receivable are
excluded from the calculation. However, given that interest
receivable is a genuine cash input, it may be legitimate to include
it in the calculation of income if it is clear that it is likely to
be a regular, stable source. See
INTM578130 for an example.
