How the interest residual works

The interest residual is operating profit after the period's interest expense, before tax:

$$\text{Residual} = \text{EBIT} - \text{Interest}$$

On $80,000,000 of EBIT against $10,000,000 of interest, the residual is $70,000,000. Interest coverage on the same sheet is $80000000 / 10000000 = 8$ times. Degree of financial leverage is $80000000 / 70000000 = 8/7$, which prints as 1.14.

Coverage is the multiple. DFL is the multiplier. This page is the leftover dollars those two both sit on.

The interest coverage calculator on this page prints the residual with the pair. The DFL explorer holds the bill still and lets you drag EBIT. Watch the residual thicken as coverage rises. Coverage against DFL is the multiple against the multiplier. This page is the $70,000,000 in the middle.

Keep EBIT at $80,000,000. Raise interest to $20,000,000. The residual falls to $60,000,000. Coverage falls to 4 times. DFL rises to $80 / 60 = 4/3$, which prints as 1.33.

Profit did not fall. The bill did. The leftover thinned by $10,000,000, the extra coupon. That is the rate-reset case in one line. Floating-rate debt that rolls into a higher coupon does this without any new borrowing. The leverage ratios on the balance sheet may not have moved at all.

EBIT $40,000,000, interest still $10,000,000. Residual $30,000,000. Coverage is 4 times, matching the second sheet. DFL is 1.33 again.

Same coverage, same DFL, different leftover: $30,000,000 is not $60,000,000. The first sheet cut the denominator. This one cut the numerator. Degree of financial leverage does not know which route produced the 4 times. The residual still names the dollars.

It is not net income. Tax has not been taken off. How NOPAT works is EBIT after tax, with no interest in the subtraction. This residual is EBIT after interest, with no tax in the subtraction. Mixing them is how one year looks like two.

It is not EBITDA. EBITDA adds D&A back to EBIT, before this subtraction. A covenant written on EBITDA coverage is using a softer top line than the $80,000,000 on this sheet.

It is not coverage. Coverage is 8. The residual is $70,000,000. Quoting 8 as if it were leftover cash is the multiple dressed as a pile.

When EBIT equals the interest bill, the residual is 0. Dividing by zero does not produce a DFL anyone can spend. Coverage is then 1: the operations earned the bill exactly once and left nothing. This calculator will not print Infinity for coverage, and it will not print a DFL at that crossing.

Just above a residual of 0, DFL is large because the leftover is thin. Further out, the leftover thickens and DFL falls toward 1. A firm with no interest expense has nothing to subtract: the residual equals EBIT, and there is no coverage ratio to take.

It is not a covenant engine, not a tax computation, and not a claim that $70,000,000 is a target. The three sheets are a $70,000,000 residual on 8 times coverage, a $60,000,000 residual after the bill doubles, and a $30,000,000 residual after EBIT halves. This is educational material, not financial advice.