One Criticism of the Interest and Fixed Charges Coverage Ratios

question 15

Essay

One criticism of the interest and fixed charges coverage ratios as measures of long-term solvency risk is that they use earnings rather than cash flows in the numerator.Detail how the interest coverage ratio and fixed charges coverage ratio are calculated.In addition,discuss why using earnings in the numerator is a problem and what method could be used to alleviate this problem.

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Definitions:

Cost Method

An accounting method used to value inventory or investments at their original cost, without considering market value changes.

Ownership Interest

A legal or equitable claim in a company or property, signifying a portion of ownership by an individual or entity.

Stock Investment

Stock investment involves purchasing shares of a company's stock in expectation of earning a return from dividends or capital appreciation.

Debt Investments

Financial assets involving funds lent to an entity (corporate or governmental) that promises to return the principal along with interest on a specified timeline.