Profitability and Coverage Analysis
3.4. Times interest earned ratio (TIE) (interest coverage ratio)
Times interest earned (TIE) ratio (also known as interest coverage ratio) measures a company's ability to meet its debt obligations. This ratio shows the number of times the company’s profit before interest and taxes (or operating income) “covers” its interest expense. The ratio is calculated by dividing earnings before interest and taxes by interest expense.
Times Interest Earned (TIE) Formula
Times interest earned is calculated by dividing earnings before interest and taxes by interest expenses for a period:
Times Interest Earned = |
Earnings before Interest and Taxes (EBIT) |
Interest Expenses |
Times Interest Earned (TIE) Ratio Example
Using the Friends Company example, let’s calculate the times interest earned ratio for fiscal year 20X9. Note that we calculated EBIT earlier (i.e., $4,440); interest expenses can be obtained from the income statements at the end of this tutorial:
Times Interest Earned Ratio = |
$4,440 |
= 20.2 times (rounded) |
$220 |
In 20X9 the company’s EBIT was 20.2 times higher than the interest expenses. This indicates that the company is financially very strong and can pay interest expenses without problems.
Important Notes
- Generally and without consideration of other ratios, a company with a high times interest earned ratio is financially strong. Lower levels of this ratio may indicate that the company’s earnings (EBIT) are not sufficient to pay the company’s debt obligations. However, in practice, when this ratio is very high, it could also mean that the company underutilizes debt. So, a careful analysis should be performed to understand the implications of different levels of times interest earned ratio.
- The numerator in the times interest earned formula should include capitalized interest (i.e., interest incurred, but not expensed because it was included in the cost of constructed fixed asset).