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Professor Dan Gode explains the importance of a company's interest coverage ratio

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Excert from The Wall Street Journal -- "The ratio can be calculated by dividing operating income—typically defined as earnings before interest and taxes, or EBIT—by its interest expense. ... 'If your coverage ratio is 1, then you have no cushion,' says Dan Gode, accounting professor at the New York University Stern School of Business. Simply: When a company’s operating earnings are equal to its borrowing costs (giving it a coverage ratio of 1.0), there is no margin for error. If the business meets a rough patch and earnings drop, then the company might not be able to pay the interest on its loans. 'If the ratio is north of 3 or 4, then you have some cushion,' Prof. Gode adds."

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