Interest Expense

What Is Interest Expense?

Interest expense is the amount of money a borrower pays to lenders for the use of borrowed funds. When a company takes out a bank loan, issues bonds, or carries a line of credit, it agrees to pay interest on the outstanding balance. That payment is recorded as interest expense. On a company's income statement, it typically appears below operating income, because it relates to how the business is financed rather than how it runs day to day.

How It Works

Interest expense accrues over time. A company does not always pay interest in cash at the moment it is incurred. Under accrual accounting, the expense is recorded in the period the debt is outstanding, whether or not cash has changed hands yet. The amount generally depends on three things: the principal balance owed, the interest rate on the debt, and the length of time the debt remains outstanding.

For bonds, the calculation can be more involved. Companies may amortize discounts or premiums on bonds, which adjusts the reported interest expense so that it reflects the true cost of borrowing across the bond's life.

Why It Matters to Investors

Interest expense is a useful signal of how much of a company's earnings are consumed by debt. Analysts often compare it with operating income through the interest coverage ratio, which shows how many times a company's operating earnings can cover its interest obligations. A low ratio can suggest financial strain, while a high ratio generally indicates more comfortable debt service.

Changes in interest expense can also reflect shifts in borrowing levels or in market interest rates. A company that refinances debt at higher rates, for example, may see its interest expense rise even if its total debt stays the same.

Interest expense is tax-relevant in many jurisdictions, since it is often deductible for businesses, which reduces taxable income. Rules on deductibility vary by country and by type of debt, so investors typically review how a company's reported figures are treated under the applicable tax regime.