Also known as a times fixed charge, a fixed charge coverage is an assessment of how many times the operating income generated by a business is more than the fixed payments currently held by that company. This type of financial evaluation can serve as a measuring stick of the company’s financial stability, as it helps to indicate how easily the business is able to meet fixed expenses. Over time, fixed charge coverage may increase or decrease, depending on what is happening with the company’s operating income and the type of times fixed charged the business currently has in place.
Companies include a number of different types of obligations into the calculation of a fixed charge coverage. Just about any fixed expense can be included, such as the rent of office or manufacturing space, interest or principal payments on outstanding debts such as business loans, or dividends issued on preferred stock. The idea is to determine if the company is capable of paying on its fixed expenses without creating additional debt in order to manage those expenses effectively.
A company may have a high fixed charge coverage, indicating that the amount of operating income generated by the business is more than sufficient to manage the fixed expenses. This is a desirable set of circumstances, since the company has some discretion in how to not only meet those expenses in a timely manner, but also how to possibly settle fixed expenses like loans earlier than projected. At the same time, a business may experience periods in which operating income is down and the fixed charge coverage is considered just sufficient to keep up with current fixed expenses, but does not provide much flexibility in the management of those expenses.
Increasing the fixed charge coverage of a business typically requires paying attention to two specific aspects of the operation. When and as possible, product sales should be increased while still keeping fixed costs more or less the same. Along with sales that increase operating income, retiring fixed expenses such as business loans helps to relieve some of the financial stress on the company’s finances, and provide more opportunity to build up financial reserves. Those reserves in turn can be used to support the business operation during periods in which income levels are down, either due to changes in the marketplace, or some type of seasonality that the company experiences during the course of the business year.
