why interest expense is calculated as a % of operating income and not revenue %



1
why interest expense is calculated as a percentage (%) of operating income and not revenue percentage?

2 Answer(s)


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The operating income is derived after the COGS and operating expenses are deducted from the revenue generated by the company. The interest and tax components are paid from the operating income, so arrived. Hence, only when it's operating income is in the positive, the company will be in a position to meet its interest payment obligation. Hence, it is more accurate and meaningful to calculate interest expense as a % of operating income rather than revenue %.

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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.

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