Do you have no idea about the times interest earned ratio? Are you willing to get some knowledge about the times interest earned ratio? If you are operating a business, it is really vital to know the economic terms for the better growth of your business.
Here in this article, I will give you a piece of knowledge about the times interest earned ratio. For better understanding, this article also offers you knowledge of times interest earned ratio with proper examples.
When you are gathering the information about the times interest earned ratio for your business, you also can not avoid the opportunity of learning the calculation of it. And luckily I will also help you with that. So, let’s get started with the definition of times interest earned ratio.
What Is The Times Interest Earned Ratio?
The times interest earned ratio or TIE ratio has several names for the same in its basket. And they are fixed-charge coverage and interest coverage ratio. All these terms refer to one single thing.
And that is the ability of a company for meeting its debt obligations obviously on a periodic basis. You can calculate this ratio by dividing the EBIT of a company by the regular interest expense.
This ratio explains the number of times that a particular company could pay its regular interest expenses, theoretically. And also whether the company should devote all of its EBIT for debt repaying or not.
Helping to quantify the probability of default of a particular company is the main purpose of the TIE or times interest earned ratio. It also helps in determining the debt parameters, such as
- The appropriate interest rate to be charged.
- The amount of debt that the company can safely go on.
So, in short, within the times earned interest ratio or you will be able to,
- Measure the number of times a company will be able to make interest payments.
- Quantify the probability of debt of a company.
- Determine the debt parameters.
When the times interest earned ratio or TIE ratio will be high for a company, that means the company has a lower probability of defaulting its loan. So, for debt providers, it is a safe investment opportunity.
On the other hand, when the times interest ratio earned will be low for a company, that means the company has a higher chance of defaulting. And the reason is less available money to dedicate for debt repayment.
In some respects, the TIE or times interest earned ratio of a company is considered also a solvency ratio. As the debt service and interest payments are generally paid on a long-term basis, they are often administered as fixed, ongoing expenses.
In case a company is not able to make the repayments with the most fixed payments, the company can go bankrupt. This is the reason why this ratio is recognized as a solvency ratio.
The Example Of The Times Interest Earned Ratio
Once you get the basic idea about the times interest earned ratio, you need to go through an example of it. With an example, you will be able to understand the concept properly.
Suppose you are applying for a loan for your business. So, as a part of the application process, the bank will want to see the financial report of your business.
As a part of the qualification process, the creditor, like banks or other financial institutions that are going to provide you a loan, just want to make sure that you or the borrower will be able to repay the loan.
Using the times interest earned ratio, the creditor will be able to understand whether the company will be able to fulfill the obligations or not. Now the financial statement shows that your company is able to generate $50,000 income before taxes and interest expenses.
Now, for the year, the overall interest and debt service of your company cost $5,000. So now, the calculation of TIE or times interest earned ratio is,
$50,000 / $5,000 = 10 times.
Therefore, your business or your company has a times interest earned ratio of 10. That means the income of your company is 10 times the annual interest expense. And your company can afford a new loan.
When the creditor or loan provider will see that there is no high risk in offering you the loan you have applied for. And you will get the loan.
Calculating Times Interest Earned Ratio
So, you have now got the basic idea about a company’s times interest earned ratio. It is time to learn the calculation of the TIE ratio.
Divide the earnings before interest and taxes of a company by the regular interest expense of the same company. The times interest earned ratio formula is
TIE Ratio = Earnings before interest and Taxes (EBIT) / Interest expense.
Here, EBIT or earnings before interest and taxes refers to the profit that a company has gained without factoring in tax and interest payments. At the same time, interest expense is the periodic legally obliged debt payments that the company has to make to its creditors.
Generally, as I have told earlier, the higher TIE ratio is better. But an excessive high TIE ratio also can indicate that the company’s management has not made any productive investment.
An excessive high times interest earned ratio implies that maybe the company is keeping all of its earnings and they are not reinvesting in business development with the help of research and development or with pursuing positive NPV projects.
And as a result of this, the company can experience a lack of profitability and also challenges that are related in the long term to sustained growth.
Frequently Asked Questions
Here are the most frequently asked questions that we have scouted over the internet and answered to further clarify your queries.
1. What Is A Good Times Interest Earned Ratio Number?
From an investor or creditor’s perspective, a corporation that has an instances hobby earned ratio extra than 2.5 is taken into consideration as a suitable hazard. Companies that have a times interest earned ratio of much less than 2. 5 are taken into consideration a far better hazard for financial disaster or default and, therefore, financially unstable.
2. What Is A Good Return Of Equity?
Usage. ROE is in particular used for evaluating the overall performance of agencies within the identical industry. As with return on the capital, and ROE is a degree of management’s cap potential to generate earnings from the equity present in it. ROEs of 15–20% is usually taken into consideration as good.
3. What Is The Meaning Of Times Interest Earned Ratio?
It is the interest rate coverage ratio.
The times interest earned (TIE) ratio, additionally referred to as the interest insurance ratio, measures how without difficulty an organization faces to pay its money owed with its present-day earnings. To calculate this ratio, you divide earnings via way of means of the entire interest payable on bonds or different varieties of debt.
4. How Do You Calculate Interest Earned?
You calculate the simple interest in a financial savings account by multiplying the account stability through the interest price by the point duration the cash is within the account. Here’s the easiet interest formula: Interest = P x R x N. P = Principal amount (the start stability).
So, now you get the idea about what the interest earned ratio is. The example that I have mentioned here is easy enough to understand the concept of the TIE ratio. With the easy formula that I have mentioned here, you yourself can easily calculate the times interest earned ratio for your company. So, before going for a loan, it will be better if you check the TIE ratio of times interest earned ratio.
the times interest earned ratio is used for all of the following except times interest earned times interest earned ratio formula times interest earned ratio high or low