Times Interest Earned Ratio, Calculate, Formula

If the debt is secured by the times interest earned ratio equals ebit divided by company assets, the borrower may have to give up assets in the event of a default. In theory, a Times Interest Earned Ratio of 2.5 or higher is considered acceptable, and a TIER of less than 2.5 suggests that a company’s debt burden may be too high. As a general rule of thumb, the higher the times interest earned ratio, the more capable the company is at paying off its interest expense on time (and vice versa). The TIE ratio is an essential tool for businesses to use to predict their future financial stability and incorporate into their operational strategies.

Times interest earned ratio: Formula, definition, and analysis

A higher ratio is favorable as it indicates the Company is earning higher than it owes and will be able to service its obligations. In contrast, a lower ratio indicates the company may not be able to fulfill its obligation. Thus, it shows how many times bookkeeping of the earnings made by the business will be enough to cover the debt repayment and make the company financially stable and sustainable. The times interest earned ratio looks at how well a company can furnish its debt with its earnings. It is one of many ratios that help investors and analysts evaluate the financial health of a company.

What are solvency ratios?

Companies and investors must regularly scrutinize this ratio alongside other solvency ratios on income and financial statements to ensure a secure financial footing. Investors and creditors often prefer a higher TIE ratio, which suggests consistent earnings and an acceptable risk level when extending capital through debt offerings. While the TIE ratio can vary widely among industries and sectors, it directly reflects a company’s financial leverage and capacity for managing debt in relation to its earnings. If your firm must raise a large amount of capital, you may use both equity and debt, and debt generates interest expense. Lenders are interested in companies that generate consistent earnings, which is why the TIE ratio is important.

Planning for cash payments

Businesses consider the cost of capital for stock and debt and use that cost to make decisions. Its total annual interest expense will be (4% X $10 million) + (6% X $10 million), or $1 million annually. Assume, for example, that XYZ Company has $10 million in 4% debt outstanding and $10 million in common stock. The company’s shareholders expect an annual dividend payment of 8% plus growth in the stock price of Budgeting for Nonprofits XYZ. Accurate figures from the income statements are vital to ensuring the calculation reflects the correct financial picture. It’s essential for companies to understand the TIE ratio, its importance, and how to use this calculation, as it illuminates a company’s fiscal fortitude against obligations.

This ratio can be calculated by dividing a company’s EBIT by its periodic interest expense. The ratio shows the number of times that a company could, theoretically, pay its periodic interest expenses should it devote all of its EBIT to debt repayment. The Times Interest Earned Ratio is calculated by dividing EBIT by the total interest expense. This ratio represents the number of times a company can cover its interest obligations using its operating earnings. In essence, it measures a company’s ability to meet its interest payments, providing a clear indication of its financial stability. Investors and analysts use this ratio, along with a range of other financial ratios, to paint a broader picture of a company’s current and future economic health.

• This ratio is a reference for lenders and borrowers in assessing a company’s debt capacity.
• A company’s Times Interest Earned Ratio plays a critical role in determining its creditworthiness.
• The ratio shows the number of times that a company could, theoretically, pay its periodic interest expenses should it devote all of its EBIT to debt repayment.
• The times interest earned formula is EBIT (company’s earnings before interest and taxes) divided by total interest expense on debt.
• A high times interest earned ratio equation will indicate a good level of earnings that it more than the interest to be repaid.