Times interest earned ratio or TIE is used as a metric for measuring the company’s ability to fulfil its obligation related debts. However, it is also called the interest coverage ratio. Also, it helps in measuring the proportionate amount of income which can be used for covering up the interest expenses in the future. TIE is considered as solvency ratio as it measures the ability of companies too. If the company failed to meet its debt, then there are chances of bankrupt.
What is the Formula: Its Example and Analysis?
For finding out the ratio, there is a formula which can be used. However, there is no doubt that Time interest earned ratio is important for the company. Well, the ratio’s formula is:
Times Interested Earned Ratio = Income before interest and Taxes or EBIT/ Interest Expenses
To find both figures, the income statement can be used as they both are mentioned there. They both are separately reported from the company’s normal operating expenses for the purpose of solvency analysis.
For example: If the company’s income statement is showing that the business made $500,00 of income, and the numbers are stated before the interest expenses and income taxes. The overall expense of the business is $50,000 in the year. What will be the time’s interest earned ratio of the company?
Well to calculate the TIE of the company, here is the calculation you need to do
Times interest earned ratio = $500,000/$50,000
The ratio will be ten times, which shows that the company’s income is ten times greater than its annual interest expense. It also shows that the company is able to pay off the additional interest expenses. Overall, the company is earning enough to stay out of chances like bankruptcy.
Analysis of Times Interest Earned Ratio:
The times interest ratio is either stated as numbers or the percentages. The ratio is used to show the company’s ability and how many times they can pay their interest with the before-tax income. This means the company prefers to have bigger numbers in ratio.
If the company’s ratio is four times, it means that the company is capable of paying the expenses for four times. Also, it shows that the company’s income is four times greater. As for the company, it can be helpful to understand how much the business is generating cash and how long they can avoid situations like bankruptcy. To create a better ratio, the company need to create reliable earning first as it will help the Times interest earned ratio as well.
For the creditors and investors, the ratio can be helpful to know if the company is able to cover future risk or not. With the help of ratio, the company can pay the interest ratio and the investor can prefer to go with the company as they are less risky. However, if the numbers are down, then the inventors will look for more options.