## What is the Times Interest Earned Ratio?

Times Interest Earned Ratio is a solvency ratio that evaluates the ability of a firm to repay its interest on the debt or the borrowing it has made. It is calculated as the ratio of EBIT (Earnings before Interest & Taxes) to Interest Expense. Higher ratio is favourable as it indicates the Company is earning higher than it owes and will be able to service its obligations. In contrast, a lower ratio indicates the company may not be able to fulfil its obligation

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked

For eg:

Source: Times Interest Earned Ratio (wallstreetmojo.com)

### Times Interest Earning Ratio Formula

**Times Interest Earned Ratio Formula** =** EBIT/Total Interest Expense**

The Times interest earned is easy to calculate and use.

- The numerator of the formula has EBITEBITEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more, 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

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 the below formula to calculate Times Interest Earned Ratio

- EBIT: 150000
- Total Interest Expense: 30000

Calculation of Times Interest Earned Ratio can be done using the 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.

#### 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 ratiosSolvency RatiosSolvency Ratios are the ratios which are calculated to judge the financial position of the organization from a long-term solvency point of view. These ratios measure the firm’s ability to satisfy its long-term obligations and are closely tracked by investors to understand and appreciate the ability of the business to meet its long-term liabilities and help them in decision making for long-term investment of their funds in the business.read more.**

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 the 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 RatioDebt To Equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. read more (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, it is 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

- Time Interest Earned Ratio: 2.5
- Total Interest Expenses: 12000000

**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 the 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.

### Volvo’s Times Interest Earned

We note from the above chart that Volvo’s Times Interest Earned has been steadily increasing over the years. It is a good situation to be in due to the company’s increased capacity to pay the interests.

## How to Use Times Interest Earned?

- Analysts should consider a time series of the ratio. A single point ratio may not be an excellent measure as it may include onetime revenue or earnings. Companies with consistent earnings will have a consistent ratio over a while, thus indicating its better position to service debt.
- However, smaller companies and startups which do not have consistent earnings will have a variable ratio over time. Thus, lenders do not prefer to give loans to such companies. Hence, these companies have higher equity and raise money from private equity and venture capitalists.
- The banks and financial lenders often look at various financial ratios to determine the solvency of the Company and whether it will be able to service its debt before taking on more debt. The banks look at the debt ratioDebt RatioThe debt ratio is the division of total debt liabilities to the company's total assets. It represents a company's ability to hold and be in a position to repay the debt if necessary on an urgent basis. Formula = total liabilities/total assetsread more, debt-equity ratioDebt-equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. read more, and Times interest earned ratio often.
- The negative ratio indicates that the Company is in serious financial trouble

### Limitations

Although a good measure of solvency, the ratio has its disadvantages. Let us have a look at the flaws and disadvantages of calculating Times interest earned ratio:

- Earnings Before Interest and taxEarnings Before Interest And TaxEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.read more used in the numerator is an accounting figure which may not be representative of enough cash generated by the Company. The ratio could be higher, but this does not indicate the Company has actual cash to pay the interest expense
- The amount of interest expense used in the denominator of the ratio is again an accounting measurement. It may include a discount or premium on the sale of the bonds and may not include the actual interest expense to be paid. To avoid such issues, it is advisable to use the interest rate on the face of the bonds.
- The ratio only considers the interest expenses. It does not account for principal paymentsPrincipal PaymentsThe principle amount is a significant portion of the total loan amount. Aside from monthly installments, when a borrower pays a part of the principal amount, the loan's original amount is directly reduced.read more. The principal payments may be huge and lead the Company to insolvencyInsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more. Further, the Company may be bankrupt or may have to refinance at the higher interest rate and unfavorable terms. Thus, while analyzing the solvency of the Company, other ratios like debt equity and debt ratio should also be considered.

### Times Interest Earned Ratio Video

### Recommended Articles

This article has been a guide to what is Times Interest Earned Ratio and its meaning. Here we discuss how to use the Times Interest Earned ratio along with practical examples, advantages, and disadvantages. You may learn more about ratio analysis from the following articles –

## Leave a Reply