The fixed charge coverage ratio is a parameter that indicates the capacity of a company to pay off its fixed charges, also known as expenses, from its income flow before going through interest and taxation. It helps define how much of the company’s income is being taken away by recurring charges.
Explanation:
The described concept revolves around the idea of fixed charges associated with opening and conducting business. These costs need to be paid regardless of how well the business is doing. The most basic example of fixed costs is a loan. If an individual took one in order to open a production line, they will have to repay it back at established intervals regardless of the product being successful in the market or not. Another example is rent, which has to be paid so long the business occupies a specific area. Finally, insurance payments are made each year at a fixed price, according to the contract.
FCCR is one of the parameters utilized to estimate a firm’s solvency and estimate how much of its own expenses it could cover per year. This parameter is important for lenders and investors to determine if a company can cover its fixed expenses per year utilizing its existent cashflow. To calculate FCCR, one requires to divide the income before tax by fixed costs. If the number is less than 1, then the business does not earn enough to cover the fixed costs. A score of one or more shows that the firm is capable of covering those basic expenditures one or several times over. While this data is not decisive when demonstrating the company’s profitability, it gives important context for the current period.