To calculate the cash coverage ratio, add depreciation and amortization back to earnings before interest and taxes (EBIT), then divide that sum by interest expense. The result is a multiple showing how many times over a company can pay its interest costs using the cash its operations actually generate. A result of 1.0x means the company barely covers interest; anything above 2.0x generally signals comfortable debt service capacity. The ratio gives a more realistic picture of debt-paying ability than net income alone because it strips out accounting deductions that never touched the company’s bank account.
The formula written out:
Cash Coverage Ratio = (EBIT + Depreciation + Amortization) / Interest Expense
The Three Numbers You Need
Three inputs do all the work. Each comes off the financial statements, and each plays a distinct role.
EBIT (Earnings Before Interest and Taxes)
EBIT captures profit from core operations before lenders or the government take a cut. You’ll often see it labeled “operating income” on the income statement. Because it ignores how a company finances itself and where it’s taxed, it isolates the earning power of the business itself.
Depreciation and Amortization
Depreciation spreads the cost of physical assets like equipment and buildings over their useful lives. Amortization does the same for intangibles like patents or proprietary software. Both reduce reported earnings, but neither involves writing a check. The cash stays in the business. That’s exactly why you add them back: they represent funds available to pay interest even though accounting rules treat them as expenses.
This is the key difference between the cash coverage ratio and the plain interest coverage ratio. Interest coverage uses only EBIT. Cash coverage uses EBIT plus D&A, producing a higher numerator and a more accurate picture of liquid resources on hand for debt service. For capital-intensive businesses with heavy depreciation, the gap between the two ratios can be large.
Interest Expense
Interest expense is the total cost of borrowing during the period, covering term loans, revolving credit lines, and any bonds the company has issued. Under accrual accounting, it hits the income statement when incurred, not necessarily when paid. One wrinkle: some companies carry paid-in-kind (PIK) interest, where interest is added to the loan balance rather than paid in cash. Analysts calculating the cash coverage ratio sometimes exclude PIK interest from the denominator because no cash actually left the building.
Where to Find the Numbers on Financial Statements
For any company registered with the SEC, start with the annual Form 10-K, which contains audited financial statements for the fiscal year.1SEC.gov. Form 10-K EBIT and interest expense both sit on the income statement, usually clearly labeled.
Depreciation and amortization take an extra step. These sometimes appear as separate income-statement lines, but more often they’re buried inside cost of goods sold or operating expenses. The reliable place to find them is the statement of cash flows. In the section reconciling net income to cash from operations, companies list every non-cash adjustment, including depreciation and amortization, as explicit add-backs. If the numbers still aren’t broken out clearly, check the financial footnotes, which include detailed schedules of property, equipment, and intangible asset amortization.
You can pull 10-Ks for free through the SEC’s EDGAR database, which offers full-text search of electronic filings back to 2001.2SEC.gov. EDGAR Full Text Search Search by company name, ticker, or CIK, and filter for 10-K filings.
Private companies don’t file with the SEC. If you’re evaluating one, the numbers come from internally prepared statements, audited statements from the company’s accountants, or a quality-of-earnings report prepared during acquisition due diligence. The same three inputs apply, but the presentation is less standardized, so you may have to reconstruct EBIT yourself rather than pull it from a labeled line.
A Worked Example
Walk through it with real numbers. Suppose a company’s most recent fiscal year shows:
- Revenue: $10 million
- Cost of goods sold: $6 million
- Operating expenses (including $500,000 of D&A): $2.5 million
- Operating income (EBIT): $1.5 million
- Interest expense: $500,000
Step one: pull EBIT. Here, $1.5 million. Step two: find D&A, which totals $500,000 and would be confirmed on the statement of cash flows. Step three: add them. $1.5 million + $500,000 = $2 million. That combined figure is the cash actually available to service debt. Step four: divide by interest expense. $2 million รท $500,000 = 4.0x. The company generates four times the cash it needs to cover interest. Healthy cushion.
Try it again with tighter numbers. A different company has $800,000 in EBIT, $200,000 in D&A, and $900,000 in interest expense. Numerator: $1 million. Denominator: $900,000. Result: 1.11x. This business barely scrapes by, with almost no margin for a bad quarter.
Reading the Result
The output is written as a multiple with an “x” after the number. What counts as good or bad depends on context, but a few bands are nearly universal.
- Below 1.0x: the company cannot cover interest from operating cash flow. It’s burning reserves, selling assets, or borrowing more just to pay interest on existing debt.
- 1.0x to 1.5x: technically covering interest, but with almost no room for error. A modest revenue dip or an unexpected expense could push the company into default. Lenders get nervous here.
- 1.5x to 2.5x: adequate coverage. The business has breathing room. Many loan covenants set their minimum requirement in this band, typically at 1.5x or 2.0x.
- Above 3.0x: strong coverage. The company can comfortably handle interest while still investing in growth and building reserves.
What counts as healthy varies by industry. Capital-intensive sectors like utilities, manufacturing, and airlines routinely carry more debt than software or consulting firms. A utility at 2.5x may be perfectly sound; the same number at a SaaS company would raise questions about why it carries so much debt relative to cash flow. Financial services firms operate on even thinner coverage because leverage is fundamental to their business model. Compare against industry peers, not a universal benchmark.
Things That Can Distort the Calculation
A few technical issues trip people up when the inputs don’t behave the way the formula assumes.
Operating leases. Current accounting standards under ASC 842 require companies to record operating leases on the balance sheet. Each lease payment is split into an amortization component and an implied interest component. That split might tempt you to add the implied interest into the denominator. Don’t. Unlike finance leases, operating leases under ASC 842 do not create actual interest expense on the income statement. The whole lease cost is recognized as a single straight-line operating expense, and the “interest” is an internal accounting construct, not a separately reported cost. Operating lease payments stay in operating expenses and don’t inflate the interest figure in your denominator.
PIK interest. As noted above, if a chunk of the reported interest expense is paid in kind rather than cash, analysts commonly strip it from the denominator so the ratio reflects actual cash outflows.
Depreciation assumptions. Companies have some discretion over depreciation methods and asset useful lives. Aggressive assumptions inflate the non-cash add-back and boost the ratio without any real change in cash generation. Worth a glance at the accounting policy footnote if the number looks unusually generous.
What the Ratio Doesn’t Tell You
The cash coverage ratio is useful, but it has blind spots worth knowing before relying on it in isolation.
- It ignores principal repayment. A company might comfortably cover interest and still struggle when large principal payments come due. The debt service coverage ratio, which includes principal in the denominator, gives a more complete picture of total debt obligations.
- It treats all cash as available for debt service. In reality, a business needs cash for capital expenditures, working capital, and taxes before paying lenders. A high ratio can mask the fact that most of the cash is already spoken for.
- It’s a backward-looking snapshot. The ratio tells you about the period that just ended. A company at 4.0x today could sign a large new debt facility tomorrow and look very different next quarter.
- It doesn’t account for the trend. Analysts watch coverage over consecutive quarters, not a single reading, because a declining trajectory often matters more than any one number.
For a complete picture of debt capacity, pair the cash coverage ratio with the debt service coverage ratio, the free cash flow to debt ratio, and a look at the maturity schedule of outstanding obligations. No single ratio captures the full complexity of a company’s financial health.