Learning Module 16: Credit Analysis for Corporate Issuers

Fixed Income

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EBIT Margin

\[ \text{EBIT Margin} = \frac{\text{Operating Income}}{\text{Revenue}} \]

• Credit analysts focus on EBIT (earnings before interest and taxes) to determine a company’s operating performance prior to capital costs and taxes, since interest expense is paid before income taxes are calculated. In some cases, EBITDA (or earnings before interest, taxes, depreciation, and amortization expense) is used as a broader measure, which adds back (non-cash) depreciation and amortization expense. Higher EBIT margins increase profits available to service debt.

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### EBIT Margin

$$
\text{EBIT Margin} = \frac{\text{Operating Income}}{\text{Revenue}}
$$

- Credit analysts focus on EBIT (earnings before interest and taxes) to 
  determine a company’s operating performance prior to capital costs and taxes, 
  since interest expense is paid before income taxes are calculated. In some 
  cases, EBITDA (or earnings before interest, taxes, depreciation, and 
  amortization expense) is used as a broader measure, which adds back 
  (non-cash) depreciation and amortization expense. Higher EBIT margins 
  increase profits available to service debt.  

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EBIT to Interest Expense

\[ \text{EBIT to Interest Expense} = \frac{\text{Operating Income}}{\text{Interest Expense}} \]

• This measures the degree to which operating profit covers periodic interest payments, with a higher coverage ratio representing less credit risk. In some cases, the numerator is changed to include depreciation and amortization (EBITDA) as well as rental expense (EBITDAR), while the denominator may be increased to include lease payments or reduced by interest earned on marketable securities and cash.

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### EBIT to Interest Expense

$$
\text{EBIT to Interest Expense} = 
\frac{\text{Operating Income}}{\text{Interest Expense}}
$$

- This measures the degree to which operating profit covers periodic interest 
  payments, with a higher coverage ratio representing less credit risk. In 
  some cases, the numerator is changed to include depreciation and amortization 
  (EBITDA) as well as rental expense (EBITDAR), while the denominator may be 
  increased to include lease payments or reduced by interest earned on 
  marketable securities and cash.  

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Debt to EBITDA

\[ \text{Debt to EBITDA} = \frac{\text{Debt}}{\text{EBITDA}} \]

• Leverage ratios are often expressed with debt either in the numerator or denominator, so care must be taken to reflect whether a greater or lesser number reflects increased leverage.

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### Debt to EBITDA

$$
\text{Debt to EBITDA} = \frac{\text{Debt}}{\text{EBITDA}}
$$

- Leverage ratios are often expressed with debt either in the numerator or 
  denominator, so care must be taken to reflect whether a greater or lesser 
  number reflects increased leverage.  

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RCF to Net Debt

\[ \text{RCF to Net Debt} = \frac{\text{RCF}}{\text{Debt - Cash and Marketable Securities}} \]

Where:

• \(RCF\): Retained Cash Flow
• Use of cash flow rather than earnings measures is also common in measuring leverage, while here the debt measure is reduced by available cash. A higher RCF to net debt measure implies lower leverage.

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### RCF to Net Debt

$$
\text{RCF to Net Debt} = 
\frac{\text{RCF}}{\text{Debt - Cash and Marketable Securities}}
$$

Where: 

- $RCF$: Retained Cash Flow
- Use of cash flow rather than earnings measures is also common in measuring 
  leverage, while here the debt measure is reduced by available cash. A 
  higher RCF to net debt measure implies lower leverage.  

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