What is the fixed charge coverage ratio?

Fixed charge coverage ratio measures a firm's ability to pay all fixed obligations (not just debt service, but also rent, lease payments, and other committed costs) from operating earnings. For professional service firms, this ratio indicates whether operations generate sufficient cash to cover all fixed commitments. A ratio below 1.0 means fixed charges exceed earnings, creating financial stress.

Key characteristics

• Measures the ability to cover all fixed obligations

• Includes debt service, rent, leases, and committed costs

• Broader than the debt service coverage ratio

• Ratio above 1.0 indicates obligations covered

• Important for assessing financial stress

• Often used by landlords and lenders

Why it matters for professional service firms

Fixed-charge coverage indicates whether a firm can meet all commitments, not just debt. A firm may cover debt service but struggle to cover total fixed charges, including rent and lease obligations. Professional service firms should track fixed charge coverage, particularly when taking on new commitments. A comfortable ratio (above 1.5) provides cushion for revenue fluctuations; a tight ratio (near 1.0) leaves no room for shortfalls.

Real-world example

Amanda's consulting firm evaluated a new office lease, which added an $8K monthly fixed cost. Current fixed charges: debt service $4K, existing lease $12K, total $16K monthly. Operating earnings (EBIT plus fixed charges): $24K monthly. Current coverage ratio: 1.50. With the new lease, fixed charges are $24K; coverage drops to 1.0 (barely covering). Decision: The new space would eliminate the financial cushion. Instead, negotiated shorter term or smaller space, or waited until earnings grew to support higher fixed charges while maintaining 1.3 minimum coverage ratio.