Explanation of Fixed Charge Coverage:

The Fixed Charge Coverage measures how well the company can cover the interest on its debt AND its lease payments with its Operating Profit.  Lease Payments are added back in to the Operating Profit, since Lease Payments were originally deducted out to get Operating Profit.

Importance of Fixed Charge Coverage:

If the company you are evaluating spends heavily on leases, such as leases on buildings and equipment, then the Fixed Charge Coverage calculation is especially important. If you look closely at this calculation of Fixed Charge Coverage, you will notice that the lower the Operating Profit, the more amplified the negative affects of the Lease Payments will become.  This somewhat reflects reality, as a company with declining Operating Profits will more readily feel the continual burden of Lease Payments combined with the Interest Expense. 

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