A coverage ratio is a financial metric used to measure a company's ability to meet its financial obligations, particularly its debt and interest payments. It compares the company's income or cash flow to its debt obligations. A higher coverage ratio indicates better financial health, as it suggests the company can more easily service its debt.

The general formula for a coverage ratio is:

\[\text{Coverage Ratio} = \frac{\text{Income or Cash Flow}}{\text{Debt Obligations}}\]In our specific calculator, we use:

\[\text{Coverage Ratio} = \frac{\text{Gross Profit}}{\text{Annual Interest & Service Charge}}\]Where:

- Gross Profit is the company's total revenue minus the cost of goods sold
- Annual Interest & Service Charge represents the company's debt obligations for the year

- Determine the company's Gross Profit for the period.
- Calculate the total Annual Interest & Service Charge for the same period.
- Divide the Gross Profit by the Annual Interest & Service Charge.
- The result is the Coverage Ratio.

Let's calculate the coverage ratio for a company with a Gross Profit of $500,000 and Annual Interest & Service Charges of $100,000:

- Gross Profit = $500,000
- Annual Interest & Service Charge = $100,000
- Coverage Ratio = $500,000 / $100,000 = 5

This means the company's gross profit is 5 times its annual debt obligations, indicating strong financial health.

In this diagram, the green bar represents the coverage ratio of 5.0. The red line marks the breakeven point (1.0). A ratio extending well beyond this line, as shown here, indicates strong financial health.

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