The interest coverage ratio is used to determine how easily a PSU can pay its interest expenses on outstanding debts. The ratio is calculated by dividing a companys earnings before interest and taxes (Ebit) by its interest expenses.
The coverage aspect of the ratio indicates how many times the interest could be paid from available earnings, thereby providing a sense of the safety margin a PSU has for paying its interest for any period.
A PSU that sustains earnings well above its interest requirements is in an excellent position to weather possible financial storms. By contrast, a PSU that barely manages to cover its interest costs may easily fall into bankruptcy if its earnings suffer for even a single quarter.
The lower the ratio, the more the company is burdened by debt expense. When a companys interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable.
The aggregated Ebit of 48 PSUsexcluding banks and NBFCsincreased by 7% to R1.38 lakh crore during 2010-11 from the level of R1.29 lakh crore during 2009-10. Their total interest expenses increased by 26% to R13,008 crore during 2010-11 from R10,323 crore a year earlier.
The top five PSUs according to the interest coverage ratio in 2010-11 were National Aluminium, Bharat Electronics, ONGC, Engineers India and Oil India.
Among the 48 PSUs, a steady increase in the interest coverage ratio during the last three years was seen with 15 companies, including ONGC, BPCL, HPCL, Power Grid Corporation, RCF, NHPC and Hind Copper. On the other hand, a steady decline in the ratio was seen with SAIL, STC, Neyveli Lignite, BEML and TCP.
Out of 48 PSUs, only two, namely STC and FACT, had an interest coverage ratio below 1.5 during 2010-11.