ACCA Applied Knowledge · Financial Accounting · Ratios
A company's profit before interest and tax is $240,000 and its finance costs are $60,000. What is its interest cover, and what does a fall in this ratio indicate?
Interest cover is 4 times, found by dividing profit before interest and tax of $240,000 by finance costs of $60,000. A fall in the ratio means a thinner profit cushion, so there is greater risk that interest cannot be paid from profits.
- A4 times; a greater risk that interest may not be met from profitsCorrect
- B3 times; a greater risk that interest may not be met from profits
- C4 times; a lower risk that interest may not be met from profits
- D3 times; lower risk of liquidity problems
Explanation
Interest cover = PBIT / finance costs = 240,000 / 60,000 = 4 times. A falling ratio means profits provide less of a cushion over interest, so risk rises. Using profit after interest (180,000) gives 3 times, which is the wrong numerator.
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