The interest cover ratio, or ICR, is a measure of how easily a business or project can make it interest payments on its debt. There are at least two different versions of the ICR, one based on cashflow and one based on profit.
The cashflow based calculation of ICR is nearly always used in project finance transactions, but can also be found elsewhere. It is the ratio of the cashflow available for debt service (or “CFADS”) to the amount of interest paid. It is almost identical to the DSCR calculation, except that principal repayments are not included in the denominator.
For further discussion on some of the variations that can be made in this ICR calculation, see the Variations section of our post on DSCR.
Leveraged finance and other corporate loans will quite often use a P&L-based ICR instead of a cashflow one (although they may refer to it as cashflow). In this formulation, the ICR is the ratio of EBITDA to interest.
The beauty of this measure is that it can be simply calculated solely using a profit and loss statement. Its weakness is that it does not capture movements in working capital (so problems in accounts receivable may be hidden) and does not include tax payments or capital expenditure. There can therefore be an incentive for a borrower to claim that payments are capital in nature rather than operating expenses, when they may in fact need to be paid to keep the business running properly.
To try and simply include capital expenditure in the ICR calculation, the calculation may use EBIT instead of EBITDA. But this turns the ICR into a lagging indicator, as investments in one period are not depreciated until future periods – meaning that the ICR is higher in the period when the money is spent, and lower when there is no money being spent. If capital requirements are reasonably constant though, this can be a good approximation of cashflow.