Times interest earned ratio shows the amount of times the 12-monthly interest expenses are included in the net running income (income previous to interest and tax) on the company. It is usually a long-term solvency rate that measures the ability of a company to pay for its interest charges when they become due. It truly is computed by dividing the income previous to interest and levy by interest bills.
Times interest earned ratio is known by various names, for example, debt service rate, fixed charges cover ratio and Levt coverage ratio.
Formula
Income before interest and tax (i.e., net operating income) and interest expense figures are available from the income statement.
Example
A creditor has extracted the following information from the income statement of ABC and requests you to compute and explain the times interest earned ratio for him.
Required: Computed times interest earned (TIE) ratio.
Solution
The times interest earned ratio of ABC company is 8.03 times. It means that the interest expenses of the company are 8.03 times covered by its net operating income (income before interest and tax).
Significance and Interpretation:
Times interest earned ratio is important from the creditors view point. A superior ratio ensures a periodical interest cash flow for lenders. The companies with weak ratio might have to face difficulties with raising funds for their operations.
Generally, a ratio of 2 or higher is considered adequate to shield the creditors’ interest in the firm. A ratio of lower than 1 means the company will have problems with paying interest on its borrowings.
