Question

The Interest Coverage (or Times Interest Earned) Ratio

This ratio indicates a business' ability to pay the interest on its debt. It is calculated:

EBIT / Interest Expense

which is easy to remember if you remember those two accounts on the income statement. EBIT is usually the line immediately before interest expense.

The Preferred Dividend Coverage Ratio

Like the Interest Coverage Ratio, this ratio indicates a business' ability to pay dividends to its preferred shareholders. It is calculated:

Net Income (before preferred dividends) / Preferred Dividends

which is also easy to remember if you remember those two accounts on the income statement.

For both ratios, the higher the better because the higher the ratio, the more profits are available for the business to pay its costs of capital. Notice also that just like on the balance sheet, creditors have a superior claim to assets than shareholders. Food for thought: consider the implications for a business that has an operating profit but a net loss before preferred dividends.

MY QUESTION FROM THE ABOVE INFORMATION IS:

What do they mean creditors have a superior claim to assets than shareholders? and what happens if a business has a operating profit but a net loss befoe preffered dividends?

Answer 1

a. What do they mean creditors have a superior claim to assets than shareholders?

Holders of equity have claims on both income and assets that are secondary to the claims of creditors in the event of liquidation

b. what happens if a business has a operating profit but a net loss befoe preffered dividends?

In case of cumulative, company can choose to accumulate the dividends payable in case of loss and pay it out to the shareholders in the year of profit. This privilege is missing in case of non-cumulative ones.