**What is FCCR?**

The **Fixed Charge Coverage Ratio (FCCR)** measures if a company’s cash flows are sufficient to cover its interest expense, mandatory debt repayment, and lease expenses.

## How to Calculate FCCR (Step-by-Step)

The fixed charge coverage ratio (FCCR) is a solvency ratio that assesses if a company’s cash flows are adequate to meet its fixed charges.

The fixed charge coverage ratio (FCCR) answers the question:

*“Does the company generate enough cash flow to meet its fixed charges?”*

**Conceptually, the FCCR represents the number of times a company could hypothetically pay off its annual fixed charges.**

Oftentimes, lenders utilize the FCCR to determine the creditworthiness of a potential or existing borrower.

Classifying costs as fixed charges requires some discretion, but in general, they have to be:

**Predictable**: The cost should be recurring and quantified with minimal variance.**Non-Discretionary**: The cost should either directly (or indirectly) contribute toward the company’s revenue generation and business model, i.e. applicable to the day-to-day operations.**Fixed Costs**: The charge should not fluctuate based on the amount of revenue, unlike variable costs.

For example, the amount due and the dates when interest expense and mandatory debt repayment come due are outlined in the loan agreement – in addition, the debt associated with these cash outflows was issued to fund operations (or related functions), and the costs were pre-negotiated (i.e. fixed).

## FCCR Formula

Broadly, FCCR is a ratio that compares an earnings metric to the total fixed charges.

There are two common approaches to calculating the FCCR, which we’ll refer to as the “GAAP” and “Non-GAAP” variations for simplicity.

The first method abides closer to GAAP accounting and divides a company’s earnings before interest and taxes (EBIT) by fixed charges before taxes plus interest expense.

**Fixed Charge Coverage Ratio =**(EBIT

**+**Fixed Charges Before Taxes)

**/**(Fixed Charges Before Taxes

**+**Interest Expense)

Suppose that a company has the following financials.

- EBIT = $250,000
- Fixed Charges = $150,000
- Interest Payments = $10,000

The numerator is equal to $450,000 ($250,000 + $150,000), whereas the denominator is equal to $160,000 ($150,000 + $10,000).

- FCCR = $450,000 / $160,000 = 2.5x

However, EBIT is a GAAP measure of profitability – thus, many equity analysts adjust the metric given the drawbacks of accrual accounting, such as the inclusion of non-cash items, most notably depreciation and amortization (D&A).

That being said, the second approach for calculating FCCR starts with a non-GAAP metric, earnings before interest, taxes, depreciation, and amortization (EBITDA).

In the non-GAAP approach, FCCR is calculated as the ratio between.

- Numerator: Adjusted EBITDA (–) Capital Expenditures (–) Cash Taxes
- Denominator: Interest Expense (+) Mandatory Debt Repayment

Capex is subtracted while D&A is added back (i.e. EBITDA) since Capex is a real cash outflow, but D&A is a non-cash expense related to accrual accounting.

**Fixed Charge Coverage Ratio =**(EBITDA

**–**Capex

**–**Cash Taxes)

**/**(Cash Interest Expense

**+**Mandatory Debt Amortization)

EBITDA is already a non-GAAP metric, yet in this context, it can be further changed by discretionary adjustments – as long as there is an agreement in writing allowing as such between the borrower and lender(s).

**The latter non-GAAP EBITDA approach is far more common in practice, whereas the GAAP EBIT approach is more often taught in academia.**

Besides interest and mandatory principal amortization, the following charges could also be included if deemed appropriate:

- Lease Payments
- Preferred Dividends
- Insurance Premiums

###### Discretionary and Non-Cash Spending

In the FCCR calculation, growth CapEx or optional prepayment of debt should be excluded since they constitute discretionary spending.

PIK interest and deferred taxes should also be excluded because they are non-cash (i.e. no real cash outflow occurred).

## How to Interpret FCCR (Industry Benchmarks)

Like the interest coverage ratio – i.e. the times interest earned (TIE) ratio – the higher the ratio, the better the company’s creditworthiness.

- FCCR = 2x → Can Pay Off Fixed Charges Twice
- FCCR = 1x → Can Pay Off Fixed Charges Once
- FCCR < 1x → Cannot Pay Off Fixed Charges

The higher FCCR, the stronger the company’s creditworthiness as a borrower – all else being equal.

Companies with higher FCCRs have less of their earnings spent on fixed charges like interest, leases, and principal repayments — therefore, more free cash flows (FCFs) remain.

Further, higher FCFs reduce the borrower’s risk of missing a scheduled payment to a third party and allow for more re-investments and discretionary spending to drive growth.