Times Interest Earned Ratio Formula (Table of Contents)
What is Times Interest Earned Ratio Formula?
Times Interest Earned Ratio can be defined as a yardstick to measure the firm’s capability to repay its interest on the debt or the borrowing it has made. The formula for Times Interest Earned Ratio is represented as follows,
Where,
- EBIT is Earnings Before Interest and Tax
The Times interest earned formula is easy to understand and use.
- The numerator of the formula has EBIT which is nothing but operating income before taxes and this is actually the income generated purely from business after deducting the expenses that are incurred necessary to run that business.
- The denominator is the total interest expense of the firm which is a burden for the firm and when EBIT is divided by total interest expenses, it can be interpreted as how many times the firm is earning to cover its interest obligation.
Examples of Times Interest Earned Ratio Formula
Let’s see some simple to advanced practical examples to understand it better.
Example #1
Company XYZ is having operating income before taxes of $150,000 and the total interest cost for the firm for the fiscal year was $30,000. You are required to compute Times Interest Earned Ratio based on the above information.
Solution
We can use below formula to calculate Times Interest Earned Ratio
Calculation of Times Interest Earned Ratio can be done using below formula as,
- = 150,000/30,00
Times Interest Earned Ratio will be –
- Times Interest Earned Ratio = 5 times.
Hence, the times’ interest earned ratio is 5 times for XYZ.
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Example #2
DHFL one of the listed companies has been losing its market capitalization in recent years as its share price has started deteriorating and from the average price of 620 per share it has come down to 49 per share market price. The Analyst is trying to understand the reason for the same and initialing wants to compute the solvency ratios.
You are required to compute Times Interest Earned Ratio from March 09 till March 18.
Solution
Here we are not given direct operating income and hence we need to calculate the same per below:
We shall add sales and other income and will deduct everything else except for interest expenses.
Calculation of EBIT for Mar -09
- EBIT = 619.76
Similarly, we can calculate EBIT for the remaining year
Calculation of Times Interest Earned Ratio can be done using below formula as,
- =619.76 – 495.64
Times Interest Earned Ratio will be –
- Times Interest Earned Ratio = 1.25
Similarly, we can calculate for the remaining years.
Example #3
Excel Industries have been facing liquidity crunches and recently it has received an order for $650 million but they lack funds to fulfill the order. The Debt to Equity Ratio (DE) of the firm is 2.50 already and it wants to borrow more to fulfill the order. The Bank has however asked the company to maintain DE ratio maximum 3 and Times Interest Earned Ratio at least 2, and at present its 2.5. It currently pays $12 million as interest and if the new borrowing puts up additional pressure of $4 million, would the firm be able to maintain Bank’s condition?
You are required to compute Times Interest Earned Ratio post new 100% debt borrowing.
Solution
First, we need to come up with EBIT which shall be a reverse calculation.
Use the following data for calculation of times interest earned ratio
Calculation of EBIT
2.5 = EBIT / 12,000,000
EBIT = 12,000,000 x 2.5
- EBIT = 30,000,000
Calculation of Times Interest Earned Ratio can be done using below formula as,
=30000000/16000000
Times Interest Earned Ratio will be –
- Times Interest Earned Ratio= 1.88
Therefore, the firm would be required to reduce the loan amount and raised funds internally as Bank will not accept the Times Interest Earned Ratio going down.
Relevance and Use
There are multiple uses of Times Interest Earned ratio around the world. Mostly this ratio is used by financial institutions such as Banks, NBFC, Cooperative banks, etc. to analyze whether the borrower has the capacity to bear debt payments and this ratio is tested along with other ratios such as debt service coverage ratio. Even the wall street analyst uses this ratio to analyze the liquidity requirement for its future CAPEX and also to check how solvent is the firm or how strong is the firm in case the firm goes bankruptcy.
Calculator
You can use these times interest earned ratio formula calculator
Recommended Articles
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