why interest expense is calculated as a % of operating income and not revenue %
2 Answer(s)
Aditya
Interest/EBITDA or EBIT (operating income) is basically a ratio vital for getting an idea on the debt servicing capability of the company. The debt would be serviced out of the profits that the company generates. No doubt revenue is an important figure but high revenue doesn't necessarily translate into sufficient profits required for the payment of interest. Thus a interest/revenue ratio could be misleading.
Jan 29 2014 01:53 AM
Abhishek
Because a company can take loan if it has sufficient interest coverage ratio i.e. EBIT/Interest expense. Taking a loan is considered as financial leverage and if EBIT is not sufficient than it can result into substantial fall in EPS and thereby stock price. EBIT comes after deducting COGS and operating expenses, then we deduct interest expense from remaining income (EBIT). Therefore, we take EBIT instead of revenue for more conservative measure.
Feb 02 2014 11:25 PM