Fixed-Charge Cover: the Ratio a Landlord or a Lender Looks At

Two definitions, and only one of them is in your agreement

The first definition comes from credit analysis and is what a textbook, a rating methodology or this calculator means by fixed-charge cover: take operating profit, add back the fixed charges that were deducted to reach it, and divide by those same charges plus interest. Optionally add scheduled principal repayment to the denominator. It is a profitability test dressed as a coverage test: everything in it comes from the income statement, and it asks whether the trading result is a comfortable multiple of the commitments that do not go away in a bad year.

The second lives in loan agreements and is a cash test. It starts from earnings before interest, tax, depreciation and amortisation, subtracts the cash the business must spend before it can pay a lender — capital expenditure that is not itself financed, cash taxes actually paid, distributions and owner's draw — and divides by cash interest, scheduled principal and rent. The two are not variants of one measure. One asks whether the business is profitable enough; the other asks whether the cash left after the owner and the taxman covers the debt. A company can pass one and fail the other in the same year, and the year it happens will be a year of heavy investment.

Both are legitimate, and both are used by people who will not tell you which they mean. The rule is therefore not to prefer one but to read the definition clause: in a facility agreement the ratio is whatever the definitions section says it is, and that text overrides every convention in this article. What follows is a way to read that clause, not a substitute for it.

What counts as a fixed charge

Three questions decide it. Is the payment contractual rather than discretionary? Is it scheduled, so that its amount and date are known in advance? Is it settled in cash within the period? Anything that answers yes three times belongs in the ratio. That admits cash interest, scheduled principal amortisation, rent and lease payments of every kind, preferred dividends where the company cannot skip them, mandatory pension contributions under a deficit recovery plan, and — in an owner-managed business, and this is the one owners resist — the drawings the household actually lives on.

It usually excludes drawings on and repayments of a revolving facility, because they are a balance not a schedule; the balloon repayment at maturity, since including it makes every amortising loan fail in its final year; voluntary prepayments; and contingent rent that varies with turnover, which is a share of the upside rather than a fixed charge. Each of these is negotiable and each has been drafted both ways, which is precisely why the definition clause matters more than the ratio. The regulator's version is instructive here: the United States Small Business Administration defines debt service as the future required principal and interest payments on all business debt including the new loan, and handles rent, owner's draw, unfinanced capital expenditure and non-recurring items as justified adjustments to operating cash flow — in the numerator, not the denominator.

From which the only rule that never bends: a fixed charge is either deducted in the numerator or added to the denominator, and never both. Rent is where this goes wrong, because it is already an expense inside operating profit and inside EBITDA. Add it to the denominator without adding it back to the numerator and you have charged the company twice for the same shop. On our figures, the consistent version is 1,800 ÷ 1,180 = 1.53× and the double-counted version is 1,200 ÷ 1,180 = 1.02×. Both look plausible on a page. Only one of them survives a 1.25 covenant.

Why leases belong in it, and what the lease standards did

A lease commitment is debt in every respect that matters to this ratio. It is contractual, it is scheduled, it is paid in cash, it does not fall when trade falls, and failing to pay it costs the business the premises it trades from — a sharper consequence than most loan defaults. Interest cover alone therefore flatters a business that rents everything and penalises the one that borrowed to buy the same assets, which is the whole reason the fixed-charge version exists.

Then the accounting moved underneath the definition. Under IFRS 16, from 2019, a lease is no longer rent: the payment is split into depreciation of a right-of-use asset and interest on a lease liability, both of which sit below the line that EBITDA stops at. Reported EBITDA therefore rose for every lessee without a euro of extra trade, and a covenant written as EBITDA over interest plus rent suddenly had a bigger numerator and a rent line that no longer existed in the accounts. Under United States rules the balance sheet moved the same way but the income statement did not: an operating lease keeps a single lease cost recognised on a generally straight-line basis inside operating expenses, so EBITDA is unaffected. The FASB itself records the difference — its model distinguishes finance and operating leases where IFRS 16 treats all leases as the former.

Two consequences follow for anyone whose covenant predates the change. First, most agreements written since have a clause freezing the accounting basis, so the ratio is computed under the standards in force when the loan was signed, whatever the audited accounts now say — which means the covenant number and the published number are supposed to differ, and the borrower must maintain both. Second, French borrowers reporting individual accounts under the plan comptable général never had the problem: crédit-bail is not capitalised there, so the royalties remain an external charge and any definition that says rent still finds it. If the same group reports on both bases, its own two calculations of the same covenant will disagree, and the agreement decides which one is the covenant.

The tax gross-up nobody mentions

Interest is deductible; repayment of principal is not. A company that owes 400 of capital repayment must earn more than 400 before tax to pay it — at a 25% rate, 400 ÷ 0.75 = 533. If your numerator is a pre-tax figure, and in the classic definition it always is, then leaving principal at its face value in the denominator understates what the business must produce. Gross it up. On our figures the denominator is 600 + 180 + 533 = 1,313 and the ratio is 1.52×; leave principal at 400 and the denominator is 1,180 and the ratio is 1.69×. The gap is 0.17× of headroom, which is more than the distance between a 1.10 covenant and a 1.25 one.

The cash definitions solve the same problem differently and must not do both. They start from EBITDA and subtract cash taxes actually paid, so the numerator is already after tax and principal belongs in the denominator at face value — which is exactly what the small-business lending rules do when they define debt service as required principal and interest and operating cash flow as EBITDA adjusted for the taxes and distributions that really leave the business. Gross up principal on a numerator that is already net of tax and you have taxed the same money twice.

The same year, eight ratios

The company is the one from the rest of this batch, with the fixed charges added: earnings before interest, tax, depreciation, amortisation and rent of 2,800, rent of 600, depreciation and amortisation of 800 — so EBITDA of 2,200 and EBIT of 1,400 — interest of 180, scheduled principal of 400, cash taxes of 300, unfinanced capital expenditure of 500 and distributions of 200, at a 25% tax rate. The table below runs eight defensible definitions across those figures. They range from 1.02× to 7.78×, a spread wider than the distance between any two covenant levels you are ever likely to negotiate.

The pair worth staring at is the fifth and the sixth: the classic form with grossed-up principal gives 1.52× and the cash form gives 1.53×. They agree to within a hundredth, and that agreement is an accident. Raise unfinanced capital expenditure from 500 to 900 next year, change nothing else, and the cash form falls to 1,400 ÷ 1,180 = 1.19× while the classic form does not move at all, because capital expenditure is invisible to it. A covenant set at 1.25 on the cash definition is breached; the same covenant on the classic definition is passed, and operating profit would have to fall 26% — from 1,400 to 1,042 — before it were reached. Two numbers that looked interchangeable in year one decide the fate of the loan in year two.

One more thing the table shows: adding a charge to both sides always drags the ratio towards 1.00. Exclude rent from both the numerator and the denominator and this company covers its debt service 2.07 times; put rent back on both sides and the same company covers its fixed charges 1.53 times. Nothing worsened. The ratio simply has more of the same money above and below the line, and any fraction above one shrinks when you add the same amount to both parts. That is why a business that leases heavily always reads tighter on a fixed-charge test than an owner does, and why a lender who wants comparability across tenants and owners has to use it anyway.

The levels asked in practice, and what a landlord is really testing

Private credit agreements set their own level, and the range you will meet in the middle market runs from about 1.10 to about 1.25, tightening as the loan amortises faster or the borrower is smaller. The clearest written floor in the public domain belongs to the United States Small Business Administration, whose loan programme rules require debt service coverage of at least 1.15 on a historical or projected basis and at least 1 to 1 on a global basis, with a lower floor of 1.10 to 1 for small 7(a) loans; operating cash flow is defined there as EBITDA, adjusted with justification for items including unfinanced capital expenditure, non-recurring income, distributions, rent payments and the owner's draw. Those rules are revised: the version numbered 50 10 8.1 takes effect on 1 October 2026, succeeding 50 10 8 of 1 June 2025, so check which is in force before quoting a number at anyone.

A landlord is asking a narrower question and usually asks it with a simpler ratio: how many times does the trading result cover the rent alone? On our figures, earnings before rent of 2,800 cover rent of 600 4.67 times, or 3.67 times if you insist on measuring after rent has been deducted, which is the same fact stated twice. The landlord is not underwriting your debt, which is why interest and principal often do not appear at all; the landlord is deciding whether a tenant who loses a fifth of its sales will still pay in month nine of a bad year. Which is why the ratio is rarely the whole test. Expect it to sit alongside a look at net worth, a parent company guarantee, a rent deposit of three to twelve months, and a filed set of accounts that is old enough for the landlord's credit agency to have scored it. If your accounts are late, the score falls and the deposit rises, and no ratio you compute will change that.

Frequently asked questions

Is fixed-charge cover the same as the debt service coverage ratio?

No, though the names are used loosely enough that you must read the definition rather than the label. Debt service coverage measures cash flow against debt only — interest plus scheduled principal. Fixed-charge cover extends the denominator to commitments that are not debt: rent above all, and then preferred dividends, mandatory pension contributions and, in an owner-managed business, drawings. On our figures the debt-only measure is 2,200 ÷ 580 = 3.79× and the fixed-charge measure is 1.53×, and the whole distance between them is the rent. Where the two matter most is a tenant-heavy business, because a company with no debt and thirty shops has an infinite debt service coverage and a perfectly ordinary fixed-charge cover.

Does the balloon repayment at maturity go in the denominator?

Almost always no, and the reason is arithmetic: a loan with a large balloon fails any coverage test in its final year, since one year of trading is being asked to cover several years of principal. Agreements therefore normally define scheduled principal as the amortisation falling due in the period, excluding the final bullet, and handle refinancing risk elsewhere — through a maturity date, a refinancing covenant or a cash sweep. Read the clause anyway, because the exclusion is drafting rather than law, and a lender who has included it has told you something about how the loan is meant to end. If it is included and you cannot change it, model the final year separately: what the ratio then measures is not your business but whether you refinanced.

My lender's number and my accountant's number differ. Who is wrong?

Probably neither, and the reconciliation takes an afternoon. Work through the differences in a fixed order: the earnings basis (EBIT or EBITDA, and whether rent is added back); the treatment of principal (included or not, grossed up or not); which leases count; whether owner drawings and capital expenditure are deducted; which twelve months are being measured, since covenants are usually tested on a rolling basis while accounts are annual; and whether a frozen-accounting clause means the covenant is computed under superseded standards. In our example those choices alone produce 1.02×, 1.19×, 1.52×, 1.53×, 1.69×, 2.07×, 2.56×, 3.59× and 3.79×. Put both calculations side by side, line by line, and the gap will name itself. Then write the agreed version into your reporting pack so the argument does not recur every quarter.

Did IFRS 16 change my covenant?

It changed the accounts underneath it, which is not the same thing. Since 2019 a lessee's rent has been split into depreciation and interest, so reported EBITDA rose and the line called rent disappeared. Whether that changed your covenant depends on the agreement: most modern facilities contain a clause freezing the accounting basis at signing, in which case the covenant is computed on the old treatment and only your published accounts moved. If yours has no such clause, then the covenant did move — usually in your favour on an EBITDA test and against you on an interest cover test, because part of the rent became interest. Ask your lender for a written confirmation of which basis applies before the next test date, not after it.

What ratio should I show a landlord who is assessing my company as a tenant?

Show rent cover and show it both ways, before and after the rent in question. The number that matters is not the current rent but the rent you are about to sign, so compute the ratio with the new lease included, and do it again on a stress case where sales fall by a fifth. Bring the pieces the landlord will otherwise assume the worst about: the last filed accounts, an up-to-date interim statement if the filed ones are old, the debt schedule so nobody double-counts your loan payments, and a note on any lease commitments that do not appear on the face of your balance sheet. If the ratio is thin, say so first and bring what compensates — a deposit, a guarantee, a shorter break clause. A landlord who finds a weakness after asking for reassurance will price it far higher than one who was told.