How is the ratio of earnings to interest and principal payments described?

The ratio of earnings to interest and principal payments, commonly referred to as the interest coverage ratio, measures a company's ability to pay its interest obligations from its earnings. This ratio is crucial for assessing the financial health of a company, especially in terms of its ability to meet debt obligations without facing financial distress. A higher interest coverage ratio indicates a greater ability to cover interest expenses, suggesting that the company is in a more secure financial position.

By focusing on the relationship between earnings (often calculated as EBIT—Earnings Before Interest and Taxes) and the costs associated with servicing debt, this measure helps stakeholders determine the risk associated with investing in or lending to a particular company. For instance, if a company's earnings significantly exceed its interest payments, it depicts strong financial health, thus providing insight to investors and creditors alike.

While financial leverage refers to the use of borrowed funds to amplify returns on investment, return on investment measures the profitability of an investment relative to its cost, and the debt ratio assesses the proportion of a company’s total debt to its assets, none of these specifically encapsulates the focus on earnings relative to interest and principal obligations as the interest cover does.