ACCA Financial Management (F9) Certification Practice Exam

Which ratio analyzes a company's ability to cover its interest expenses?

1. Acid Test Ratio

2. Current Ratio

3. Interest Cover

4. Return on Equity

The correct answer is: Interest Cover

The ratio that specifically analyzes a company's ability to cover its interest expenses is the Interest Cover ratio. This ratio measures how easily a company can pay interest on its outstanding debt by comparing its available earnings before interest and taxes (EBIT) to its interest expenses. A higher Interest Cover ratio indicates that the company has a greater ability to meet its interest obligations, suggesting financial stability and reduced risk for creditors. The Acid Test Ratio and Current Ratio, while useful in assessing liquidity and short-term financial health, focus on the company's ability to meet its current liabilities with its current assets rather than its capacity to cover interest expenses. Return on Equity measures a company's profitability relative to shareholder equity and does not provide insight into how well a company can meet its debt obligations. Therefore, the Interest Cover ratio is distinctly positioned to evaluate the specific area of interest expense coverage.