Understanding the Times Interest Earned Ratio

The times interest earned ratio (also known as the interest coverage ratio) is an important measure of a company’s financial health and serves as an indicator of a company’s ability to meet its financial obligations. The ratio is calculated by finding the ratio of a company’s earnings before interest and taxes to its interest expense for a given period.

The times interest earned ratio indicates the number of times a company can pay its interest expense with its earnings before interest and taxes. The higher the ratio, the more easily a company can cover its interest payments and the more secure its financial health. The ratio can be used to compare the financial performance of companies in the same industry.

The formula for calculating the times interest earned ratio is:
Earnings Before Interest and Tax (EBIT) ÷ Interest Expense.

For example, if a company has an EBIT of $50,000 and an interest expense of $5,000, its ratio would be 10. That would mean that the company can cover its interest payments 10 times with its before interest and tax earnings.

It is important to note that the times interest earned ratio is just one of many ratios and numbers that should be looked at when assessing the financial performance of a company. A higher ratio indicates that the company’s earnings are strong enough to cover its debts, however it does not necessarily indicate that the company is doing well or that it will remain financially secure in the future.

Studying the times interest earned ratio can provide valuable insight into a company’s financial well-being, and can help investors make more informed decisions when considering which companies to invest in.