UPSC Prelims 2020 · Question 72 of 100
UPSC Prelims 2020 question on Interest Coverage Ratio
- ExamUPSC CSE
- Year2020
- PaperGeneral Studies Paper I
- SubjectIndian Economy
- TopicBanking
- DifficultyHard
- TypeStatement
What is the importance of the term 'Interest Coverage Ratio' of a firm in India?
1. It helps in understanding the present risk of a firm that a bank is going to given loan to.
2. It helps in evaluating the emerging risk of a firm that a bank is going to give loan to.
3. The higher a borrowing firm's level of Interest Coverage Ratio, the worse is its ability to service its debt.
Select the correct answer using the code given below:
Show answer
Answer: A. 1 and 2 only
Verdict
Correct statements: 1 and 2 → Option (a).
Analysis
The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. A higher coverage ratio is better, although the ideal ratio may vary by industry.
Statement by statement
Statement 1 – CORRECT: The interest coverage ratio is used to see how well a firm can pay the interest on outstanding debt. Also called the times-interest-earned ratio, this ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm — including the present risk of a firm that a bank is going to loan to. Hence statement 1 is correct.
Statement 2 – CORRECT: The Interest coverage ratio is also called 'times interest earned.' Lenders, investors, and creditors often use this formula to determine a company's riskiness relative to its current debt or for future borrowing — thus helping evaluate emerging risk too. Hence statement 2 is correct.
Statement 3 – INCORRECT: The higher a borrowing firm's level of Interest Coverage Ratio, the BETTER is its ability to service its debt (not worse). A higher ratio means the firm earns more than enough to cover its interest payments. Hence statement 3 is not correct.