# Fixed-Charge Coverage Ratio Explained: Definition, Formula, and Benefits

## What Is the Fixed-Charge Coverage Ratio (FCCR)?

The Fixed-Charge Coverage Ratio (FCCR) is essential for evaluating how well a company can cover its fixed expenses, including debts and leases. By examining how earnings meet fixed charges, the FCCR provides insight into a company's financial health and serves as a key measure for banks assessing loan eligibility.

### Key Takeaways

*   The Fixed-Charge Coverage Ratio (FCCR) assesses a company's ability to meet fixed expenses, such as debt payments, lease expenses, and interest fees.
*   A higher FCCR indicates stronger financial health and suggests that a company can manage its fixed charges and potentially take on additional debt responsibly.
*   Calculating FCCR involves adding earnings before interest and taxes (EBIT) to fixed charges before tax and dividing by the total of fixed charges before tax and interest.
*   Lenders use the FCCR, among other ratios, to evaluate a company's creditworthiness and cash flow availability for debt repayment.
*   The FCCR has limitations, such as not accounting for rapid capital changes or owner withdrawals, so additional metrics are often required for a comprehensive financial assessment.

![Fixed-Charge Coverage Ratio](https://www.investopedia.com/thmb/vAzuX1uhNnyeZGgsjI756ychIXw=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Fixed_Charge_Coverage_Ratio_Final-d26ac6294fcd40b8a3746ea67c0b31a9.png)

*— Candra Huff / Investopedia*

## The Fixed-Charge Coverage Ratio Formula

$\begin{aligned} &FCCR = \frac{EBIT + FCBT}{FCBT + i} \\ &\textbf{where:}\\ &EBIT=\text{earnings before interest and taxes}\\ &FCBT=\text{fixed charges before tax}\\ &i=\text{interest}\\ \end{aligned}$

## Steps to Calculate the Fixed-Charge Coverage Ratio

To calculate a [company'](https://www.investopedia.com/terms/c/company.asp)s ability to cover fixed charges, start with [earnings before interest and taxes (EBIT)](https://www.investopedia.com/terms/e/ebit.asp) and add interest, lease, and other fixed expenses.

Next, the adjusted EBIT is divided by the amount of fixed charges plus interest. A ratio result of 1.5, for example, shows that a company can pay its fixed charges and interest 1.5 times out of earnings.

## How to Interpret the Fixed-Charge Coverage Ratio for Business Health

Lenders use this ratio to analyze a company's [cash flow](https://www.investopedia.com/terms/c/cashflow.asp) available for debt repayment. A low ratio indicates the company might struggle with fixed payments, posing a risk for lenders.

To avoid risk, many lenders use coverage ratios like the [times interest earned (TIE) ratio](https://www.investopedia.com/terms/t/tie.asp) and the FCCR. These help determine if a company can take on and pay for more debt. Companies that cover fixed charges faster than their peers are more efficient and more profitable. This is a company that wants to borrow to finance growth rather than to get through a hardship.

The [income statement](https://www.investopedia.com/terms/i/incomestatement.asp) of a company shows its sales and related costs. Some costs change with sales volume, increasing as sales increase. Fixed costs must be paid whether or not there is activity. These can include equipment leases, insurance, debt payments, and preferred dividends.

## Example of Calculating FCCR

The purpose of calculating the FCCR is to see how well earnings cover fixed charges. Unlike the TIE ratio, FCCR includes extra fixed charges like lease expenses, making it more conservative.

While similar to TIE, the fixed-charge coverage ratio accounts for more expenses. The fixed-charge coverage ratio adds lease payments to earnings before income and taxes (EBIT) and then divides by the total interest and lease expenses.

Let's say Company A records EBIT of $300,000, lease payments of $200,000, and $50,000 in interest expense. The calculation is $300,000 plus $200,000 divided by $50,000 plus $200,000, which is $500,000 divided by $250,000, or a fixed-charge coverage ratio of 2×.

The company's earnings are twice its [fixed costs](https://www.investopedia.com/terms/f/fixedcost.asp), which is low. It can only cover fixed charges twice with current earnings, increasing the future payment risk. The higher this ratio is, the better.

> **Important**
>
> Like the TIE ratio, the higher the FCCR, the better.

## Limitations of the Fixed-Charge Coverage Ratio You Should Know

The FCCR doesn't consider rapid changes in the amount of [capital](https://www.investopedia.com/terms/c/capital.asp) for new and growing companies. The formula also doesn't consider the effects of funds taken out of earnings to pay an owner's draw or pay dividends to investors. These events affect the ratio inputs and can give a misleading conclusion unless other [metrics](https://www.investopedia.com/terms/m/metrics.asp) are also considered.

For this reason, when banks evaluate a company's [creditworthiness](https://www.investopedia.com/terms/c/credit-worthiness.asp) for a loan, they typically look at several other benchmarks in addition to the fixed-charge coverage ratio. This gives them a more complete view of the company's financial condition.

## How Do I Calculate the Fixed-Charge Coverage Ratio?

Add earnings before interest and taxes (EBIT) and fixed charges before tax (FCBT), and divide it by the summary of FCBT plus interest. The quotient is the fixed-charge coverage ratio (FCCR).  

## How Is the Fixed-Charge Coverage Ratio Used?

Banks will often look at the FCCR when evaluating whether to lend money to a business. Lenders analyze the amount of cash flow a company has available for debt repayment.

## What Does the Fixed-Charge Coverage Ratio Not Take Into Account?

The FCCR doesn’t consider:

*   Rapid changes in the amount of capital for new and growing companies
*   The effects of funds taken out of earnings to pay an owner’s draw or pay dividends to investors

Both events affect the ratio inputs and can give a misleading conclusion unless other metrics are also considered. This is why banks usually look at several other benchmarks in addition to the fixed-charge coverage ratio when they evaluate a company’s creditworthiness for a loan.

## The Bottom Line

The Fixed-Charge Coverage Ratio (FCCR) is a critical tool for evaluating a company's financial stability by measuring its ability to meet fixed financial obligations, including debt payments, interest expenses, and leases. A higher FCCR signifies that a company efficiently covers these obligations, thus enhancing its attractiveness to banks and lenders seeking to gauge creditworthiness. Lenders favor companies with a higher FCCR as it suggests stronger financial health and the potential to responsibly manage additional debt.