It is calculated by dividing a company’s earnings before interest and taxes (EBIT) by its interest expense within a specific period, typically a year. With our times interest earned ratio calculator, we strive to assist you in evaluating a company’s ability to meet its interest obligations. For further insights, you might want to explore our debt service coverage ratio calculator and interest coverage ratio calculator. A good TIE ratio is at least 2 or 3, especially in economic times when EBIT can fall due to revenue drops and cost inflation effects, and interest expense rises on variable rate debt as the Fed raises rates. The relatively high TIE ratio means the company’s EBIT is 2 to 3 times its annual interest expense, which is a margin of safety for the risk of making interest payments on debt. The times interest earned ratio (interest coverage ratio) can be used in combination with a net debt-to-EBITDA ratio to indicate a company’s ability for debt repayment.

Analysis

Times interest earned (TIE) or interest coverage ratio is a measure of a company’s ability to honor its debt payments. It may be calculated as either EBIT or EBITDA divided by the total interest expense. Conceptually identical to the interest coverage ratio, the TIE ratio formula consists of dividing the company’s EBIT by the total interest expense on all debt securities.

Times Interest Earned Ratio Example in Corporate Finance

• If a company raises capital using debt, management must determine if the business can generate sufficient earnings to make all interest payments on debt.
• The balances of the amount of debt borrowed from financial lenders or created through bond issuance, less repaid amounts, are included in separate line items in the liabilities section of the balance sheet.
• If your firm must raise a large amount of capital, you may use both equity and debt, and debt generates interest expense.
• Lower values highlight that the company may not be in a position to meet its debt obligations.
• The result is a number that shows how many times a company could cover its interest charges with its pretax earnings.

Eliminate annoying banking fees, earn yield on your cash, and operate more efficiently with Rho. See why progress invoicing and receiving partial payments is highly beneficial. GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments. In contrast, Company B shows a downside scenario in which EBIT is falling by $10m annually while interest expense is increasing by $5m each year.

What’s an Example of TIE?

A company might have more than enough revenue to cover interest payments but it may face principal obligations coming due that it won’t be able to pay. A higher times interest earned ratio is favorable because it means that the company presents less of a risk to investors accounting explained with brief history and modern job requirements and creditors in terms of solvency. An organization that has a times interest earned ratio greater than 2.5 is considered an acceptable risk. Companies that have a times interest earned ratio of less than 2.5 are considered a much higher risk for bankruptcy or default.

What is the times interest earned ratio?

Due to Hold the Mustard’s success, your family is debating a major renovation that would cost $100,000. Create and enforce a formal collection process to avoid incurring bad debt expenses, which decrease earnings. Review all of the costs you incur, and identify areas where costs can be reduced. If you can purchase a product through multiple suppliers, you can force the suppliers to compete for your business and offer lower prices.

Based on this TIE ratio — hovering near the danger zone — lending to Dill With It would probably not be deemed an acceptable risk for the loan office. Again, there is always more that goes into a decision like this, but a TIE ratio of 2.5 or lower is generally a cause for concern among creditors. When you sit down with the financial planner to determine your TIE ratio, they plug your EBIT and your interest expense into the TIE formula. In a perfect world, companies would use accounting software and diligence to know their position and not consider a hefty new loan or expense they couldn’t safely pay off.

But even a genius CEO can be a tad overzealous and watch as compound interest capsizes their boat. Successful businesses have a formal process to follow up on late payments. For example, your firm may email customers when an invoice is 30 days old and call clients if an invoice reaches 45 days old. Non-responsive customers should be sent to collections for more follow-up. Attempt to negotiate better terms on leases and other fixed costs to lower total expenses. Businesses can increase EBIT by reviewing business operations in order to increase profit margins.

It is more an indicator of solvency, financial health, and credit risk than pure profitability. Specifically, the times interest earned ratio measures how well a company can cover its interest payments due on outstanding debt. It calculates the number of times a company’s earnings before interest and taxes (EBIT) covers its interest expense due over a period. You can’t just walk into a bank and be handed $1 million for your business. With that said, it’s easy to rack up debt from different sources without a realistic plan to pay them off.

To better understand the TIE, it’s helpful to look at a times interest earned ratio explanation of what this figure really means. You could look at the TIE as a solvency ratio, because it measures how easily a business can fulfil its financial obligations. Interest payments are used as the metric, since they are fixed, long-term expenses. If a business struggles to pay fixed expenses like interest, it runs the risk of going bankrupt. In this way, the ratio gives an early indication that a business might need to pay off existing debts before taking on more. A higher times interest earned ratio indicates a greater cushion for the company to cover its interest obligations, meaning improved solvency.

Assume, for example, that XYZ Company has $10 million in 4% debt outstanding and $10 million in common stock. The cost of capital for issuing more debt is an annual interest rate of 6%. The company’s shareholders expect an annual dividend payment of 8% plus growth in the stock price of XYZ.