Financial Ratios Part 20 of 21: Interest-Expense ratio
How much of a business or farms’ gross income is being spent to pay interest on borrowed money?
Financial ratios & indicators can assist in determining the health of a business. There is a minimum of 21 different ratios and indicators that can be looked at by many financial institutions. You cannot look at a single ratio and determine the overall health of a business or farming operation. Multiple ratios and indicators must be used along with other information to determine the total and overall health of a farming operation and business. This series of articles will look at 21 commonly used ratios and indicators.
Interest-Expense Ratio is a measurement of financial efficiency and is determined based on information derived from a business’ or farm operations financial statements specifically using the financials that determine gross farm income. Financial efficiency refers to how effectively a business or farm is able to generate income. Looking at the financial efficiency of a business or farm assists the owner(s) in determining how the various aspects of the business such as production, financing, marketing, etc. effects the gross income of the business.
Interest-Expense ratio is measured as a percentage, the lower the percentage the stronger the ratio. The Interest-Expense ratio intimates the amount of gross income that is being spent to pay the interest on borrowed money. The lower the percentages the better, a business or farm should be no higher than 5% to be considered strong. A Interest-Expense ratio higher than 10% indicates that the business or farm is spending too much of its gross income paying interest on borrowed money. In this case a business or farm may want to look at ways to lower this expense, this can be accomplished in a number of ways including: selling of assets to pay down overall debt (negative ramification for this may include tax issues), refinancing some loans, and restructuring of debt.
When you take the following financial ratios and add them up they should total 100%:
- Operating-Expense Ratio
- Depreciation-Expense Ratio
- Interest-Expense Ratio
- Net Income Ratio.
The following equation(s) will determine your Interest-Expense Ratio:
Interest-Expense Ratio = Interest Expense / Gross Income
You can read the other articles in this series:
Part 1: The current ratio
Part 2: Working capital.
Part 3: Working capital to gross revenues
Part 4: Debt-to-asset ratio
Part 5: Equity-to-asset ratio
Part 6: Debt-to-equity ratio
Part 7: Net farm income
Part 8: Rate of return on assets
Part 9: Rate of return
Part 10: Operating profit margin
Part 11: The EBITDA measurement of profitability
Part 12: Operating profit margin
Part 13: Capital debt repayment margin
Part 14: Replacement margin
Part 15: Term debt coverage
Part 16: Replacement margin coverage ratio
Part 17: Asset turnover rate
Part 18: Operating-expense ratio
Part 19: Depreciation-expense ratio
Part 21: Net income ratio