Times Interest Earned Ratio

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

Times-Interest-Earned-Ratio-Formula

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.

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,

Times Interest Earned Ratio Formula Example 1.1
  • = 150,000/30,00

Times Interest Earned Ratio will be –

Example 1.2
  • 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.

Times Interest Earned Ratio Formula Example 2

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

Times Interest Earned Ratio Formula Example 2.1
  • EBIT = 619.76

Similarly, we can calculate EBIT for the remaining year

Example 2.2

Calculation of Times Interest Earned Ratio can be done using the below formula as,

Times Interest Earned Ratio Formula Example 2.3
  • =619.76 – 495.64

Times Interest Earned Ratio will be –

Example 2.4
  • Times Interest Earned Ratio = 1.25

Similarly, we can calculate for the remaining years.

Example 2.5

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

Times Interest Earned Ratio Formula Example 3.1

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,

Times Interest Earned Ratio Formula Example 3.2

=30000000/16000000

Times Interest Earned Ratio will be –

Example 3.3
  • 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?

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:

Times Interest Earned Ratio Video

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 –

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *