Detailed Explanation:

Answer: Option 1 — 1 and 2 only

The Interest Coverage Ratio (ICR) is a key financial metric used by banks and creditors to assess a firm's ability to meet its interest obligations from its operating earnings. It helps evaluate both the current creditworthiness and emerging financial risks of a borrowing firm.

✅ Statement 1 – Correct: ICR helps understand the present risk by showing whether the firm currently has sufficient earnings to cover interest payments; a low ICR signals immediate difficulty in servicing debt.

✅ Statement 2 – Correct: ICR also helps evaluate emerging risks; a declining trend in ICR over time indicates growing financial stress and potential future default risk.

❌ Statement 3 – Incorrect: A higher ICR indicates better ability to service debt, not worse; it means the firm has a comfortable earnings cushion to meet interest obligations.

📝 Short Notes: Interest Coverage Ratio (ICR)

• Definition: ICR = Earnings Before Interest and Tax (EBIT) ÷ Interest Expense. It measures how many times a company can pay its interest obligations from its operating profit.
• Interpretation: An ICR of 2.5 or higher is generally considered healthy, meaning the company earns at least 2.5 times its interest obligations.
• Risk Assessment: ICR below 1.5 is typically considered risky, as it indicates insufficient earnings buffer to cover interest payments comfortably.
• Banking Use: Banks use ICR as a critical parameter in credit appraisal to determine loan eligibility and interest rates; lower ICR may lead to loan rejection or higher interest rates.
• Trend Analysis: A declining ICR trend signals deteriorating financial health and increased default risk, even if the current ratio appears acceptable.
• Limitation: ICR does not account for principal repayment obligations; it only measures ability to pay interest, not total debt servicing capacity.