Times interest earned (TIE) is one of the many financial calculations that measure a business’s ability to pay back its debts. This ratio, sometimes called the interest coverage ratio, measures the relative amount of a company’s earnings available for use on interest expenses in the future. While technically considered a coverage ratio, TIE often times serves as a solvency ratio when financial institutions use it to evaluate small businesses seeking loans.
Calculating Times Interest Earned
You can use EBIT (earnings before interest and taxes) or EBITDA (earnings before interest, taxes, depreciation, and amortization) to calculate your small business’s TIE. Many businesses figure it both ways to get a better grasp on their particular financial situations. The formula for using either figure is: EBIT or EBITDA divided by Interest Expense equals your Times Interest Earned.
Times Interest Earned Example
Assume a business’s latest income statement shows $250,000 of earnings before interest and taxes, and its total income expense for the year is $50,000. To calculate its TIE, divide the $250,000 by $50,000 for a TIE that totals 5. This means that the business makes enough to cover its interest expenses five times over, which points to it having financial stability.
Reasons for Calculating TIE
Your small business needs to calculate its TIE, because a lower number can signal that you operate at a risky level. This means you have trouble generating enough earnings to cover your debt servicing and may be extremely vulnerable to interest rate increases that increase your loan payments. Also, if you seek bank loans to raise more capital, financial institutions look at your TIE value when deciding whether to lend your small business money. Higher TIE numbers suggest your company has the ability to pay off its debt, which boosts your chances for loan acceptance.
Tracking your TIE number helps you know when your small business has smooth sailing ahead or points to rough waters. This makes it an important figure to calculate, even if you don’t expect to need a loan soon. QuickBooks Online helps you keep tabs on your financial numbers with numerous reports available with minimal effort. 5.6 million customers use QuickBooks. Join them today to help your business thrive for free.