Profitable is not the same as solvent.
Two companies, same operating profit this year, both firmly in the black. The only difference is the size of the interest bill sitting under each. Divide one by the other and the gap opens up.
| Times interest earned |
Company A |
Company B |
| Operating profit . EBIT | 300 | 300 |
| Interest bill | 60 | 200 |
| Coverage . EBIT over interest | 5.0x | 1.5x |
Both look fine. Now serve up an ordinary bad year and knock 40 pct off operating profit for both. Company A still covers its interest 3 times over. Company B drops to 0.9, its profit no longer covers the interest at all, and the year flips to a loss. It would take an 80 pct collapse to put A in that spot. Company B only needed a 33 pct dip. Same headline profit. One has a cushion, the other has a trapdoor.