The times interest earned ratio shows how able a company is, to fulfil the interest payments on its debt. To calculate the times interest earned, the corporation’s income before interest and income tax expense is divided by interest expense.

BREAKING DOWN Times Interest Earned – TIE

Inability to pay interests on debt could make a company go bankrupt. TIE is also referred to as the interest coverage ratio.

If a company is producing good earnings, it can generate good cash flow through which the payments of principal and interests can be made convinient saving the company from bankruptcy. When a company raises its funds by issuing stock or debt it is referred to as capitalization of the company and TIE experience a noticeable impact by the choices made fir capitalization.

Formula to calculate Times Interest Earned Ratio

Times Interest Earned Ratio = Income before Interest and Taxes or EBIT/Interest Expense

Usually, Income statement displays both the figures. There is separate treatment of Interest expense and income taxes from the normal operating expenses for analysing solvency. This also helps in convinient calculations of the earnings before interest and taxes or EBIT.

Example

Vovno Tile Service deals in construction projects that is planning to apply for a new loan to purchase equipment. The bank demands the financial statements of the company before they consider to permit their loan. Vovno’s income statement shows that they made $500,000 of income before interest expense and income taxes. Vovno’s overall interest expense for the year was only $50,000. Time interest earned ratio would be calculated as:

Times Interest Earned Ratio = $500,000/$50,000

TIE = 10 times

Vovno has a ratio of ten. This clealy indicates that Vovno’s income is 10 times greater than their annual interest expense. Simply put, Vovno is definitely in a good condition to pay additional interest expenses. In this respect, Vovno is prone to lesser risks and the bank shouldn’t have a problem accepting their loan.