Interest Coverage vs Fixed Charge Ratio (FCCR), Explained
The question
Explain the difference between interest coverage and the fixed charge coverage ratio. Why can a company look safe on one and tight on the other?
General educational practice only. This is not an actual, confidential, leaked, or firm-provided interview question. Check important technical details against primary learning materials.
The answer
Interest coverage is EBITDA divided by cash interest expense; the fixed charge coverage ratio subtracts capex from EBITDA and divides that by cash interest plus mandatory debt amortization, sometimes including cash taxes.
So interest coverage only asks whether EBITDA covers the interest bill, while the fixed charge coverage ratio asks whether cash flow after essential reinvestment covers everything the company is obligated to pay: interest, scheduled principal, and the maintenance capex it cannot skip.
A company can look safe on interest coverage if its interest burden is manageable, but still look tight on fixed charge coverage when mandatory amortization is heavy or maintenance capex is high. That is why lenders covenant on the fixed charge coverage ratio as the stricter test: a business can easily cover interest yet still face a liquidity squeeze from the other required outflows.
Sources & uses
| Term Loan B | 400 |
| Senior notes | 250 |
| Sponsor equity | 370 |
| Total sources | 1,020 |
| Purchase of equity | 900 |
| Refinance existing debt | 100 |
| Financing & advisory fees | 20 |
| Total uses | 1,020 |
Also asked as
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- A company has $90M EBITDA, $20M cash, $200M TLB, and $150M senior notes. Compute total leverage and net leverage.
- What is the practical difference between a maintenance covenant and an incurrence covenant, and which is more common in a cov-lite term loan B?
- A capital structure has 3.5x first-lien leverage and 6.5x total leverage. What does the 3.0x gap tell you about the risk profile of the first-lien tranche, and how would you expect that tranche to be priced relative to the subordinated debt?
- A company's GAAP EBITDA is $80M but its credit-agreement EBITDA with add-backs is $105M, against $500M of debt. Compute leverage both ways and explain why a credit investor should care about the difference.
- A maintenance covenant caps net leverage at 5.5x. The company is currently at 4.8x with $110M EBITDA and net debt of $528M. How much can EBITDA fall (holding debt constant) before the covenant is breached? Express the answer both in dollars and as a percentage decline.
- A subordinated note is a cash/PIK toggle currently paying cash. EBITDA is expected to fall 20% next year due to a demand shock. Explain, with the mechanics, how flipping the note to full PIK would affect interest coverage versus total leverage in opposite directions, and whether you'd recommend the company do it.
- Year 1: EBITDA $100M, net debt $550M (5.5x). The covenant steps down from 6.0x to 5.25x in year 2. Base case: EBITDA grows 6% and $35M of debt is paid down. Compute year 2 leverage under the base case, then under a downside where EBITDA instead falls 10% and debt paydown slows to $10M. Does the covenant hold in the downside?
- Explain what a cross-default provision is and why it means credit stats for one tranche can't always be analyzed in isolation from the rest of the capital structure.
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