Times interest earned (TIE) is one of the many financial calculations used to 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 this ratio is considered a coverage ratio, often times financial institutions look at TIE as a solvency ratio. TIE may use either EBIT (earnings before interest and taxes) or EBITDA (earnings before interest, taxes, depreciation, and amortization) in its calculation but many businesses calculate it using both. The formula for TIE is:Times Interest Earned = (EBIT or EBITDA) / Interest ExpenseLets assume a business’s latest income statement shows $250,000 of earnings before interest and taxes. The business’s total income expense for the year is $50,000. Thus, the TIE is calculated as $250,000 / $50,000 = 5. A higher TIE is always preferable to a lower TIE. Small businesses need to calculate the TIE for two major reasons. The first is that a low TIE can signal that the business is operating at too risky a level. A low TIE means that the business has trouble generating enough earnings to cover its debt servicing, and it may be extremely vulnerable to increases in interest rates, which might affect the amount of its loan payments. Second, if the business needs to raise more capital through bank loans, the bank looks at the TIE value. If it is too low, the bank may consider the loan a losing proposition and decline to offer it. A low TIE is a dangerous sign. Businesses should do all they can to increase their TIE levels.
Information may be abridged and therefore incomplete. This document/information does not constitute, and should not be considered a substitute for, legal or financial advice. Each financial situation is different, the advice provided is intended to be general. Please contact your financial or legal advisors for information specific to your situation.