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Fixed Charge

Fixed Charge
BusinessCorporate Finance and AccountingCorporate Finance

What Is a Fixed Charge?

A fixed charge is any type of expense that repeats consistently, no matter what the volume of business. Fixed charges for the most part incorporate loans (principal and interest) and lease payments, however the definition of "fixed charges" may widen out to incorporate insurance, utilities, and taxes for the reasons for drawing up loan covenants by lenders.

Grasping Fixed Charges

Before a business sets up, it records every one of the vital upfront and progressing expenses. The expenses are then separated into two cans: fixed and variable. The variable expenses rely upon the volume of business. For instance, a sales rep's not entirely set in stone by the amount of the company's products or services are sold. Fixed expenses, then again, exist no matter what the volume of business.

All companies have fixed charges in some form. From the very first moment a company conveys fixed charges. The two major categories of fixed charges are loan payments and lease payments, taking everything into account.

The Fixed Charge Coverage Ratio

A lender may likewise capture other fixed expenses like insurance, utilities, and taxes, however most loan contracts for the fixed charge coverage ratio (FCCR) center around loan and lease payments. The FCCR is a rare example of important measures of the repayment capacity of a borrower; clearly, the higher the coverage ratio - which utilizes earnings before interest and taxes (EBIT) as the numerator and fixed charges as the denominator - the better.

The fixed charge coverage ratio is like the interest coverage ratio. The massive difference between the two is that the fixed charge coverage ratio accounts for the yearly obligations of lease payments notwithstanding interest payments.

This ratio is sometimes seen as an expanded rendition of the times interest coverage ratio or the times interest earned ratio. Assuming the subsequent value of this ratio is low, under 1, it is a strong indication that any critical lessening in profits could achieve financial insolvency for a company. A high ratio is indicative of a greater level of financial sufficiency for a company.

A variation of FCCR is earnings before interest, taxes, depreciation, and amortization (EBITDA) over fixed charges. A company that has oppressive fixed charges and deficient volumes of business to cover the fixed expenses, let alone the variable ones, will be in a difficult situation with its creditors, who have collateral on business assets and at times personal assets too.

Illustration of a Fixed Charge

Government Realty Investment Trust, a REIT, records fixed-rate debt (principal and interest), capital lease obligations (principal and interest), variable rate debt (principal just), and operating leases among its fixed charges. As of the finish of the main quarter of 2021, the REIT had a fixed charge coverage ratio of 3.1x.

Highlights

  • A fixed charge is a recurring and unsurprising expense incurred by a firm.
  • Dissimilar to a variable charge, the fixed charge continues as before no matter what the amount of business led.
  • Fixed charges are most frequently associated with lease or loan payments, yet may likewise cover standard bills like utilities or insurance payments.
  • The fixed charge coverage ratio is utilized to measure the solvency of a company and is utilized by lenders to survey the firm's ability to borrow and service debt.