What is Time Interest Earned Ratio
Time interest earned ratio is a financial ratio that comparison between the earnings before interests and taxes (EBIT) and the interest expense within a year. The time interest earned ratio measures the number of available income for interest payment (and other fixed charge obligations).
The time interest earned ratio reflects the number of dollars of operating earnings available to pay for each dollar of interest. The time interest earned ratio (TIE) value of 1 means that $1 of the operating profit is available to meet exactly the annual interest expenses.
The ratio report shows how many times a company could theoretically pay its recurring interest expense if it devoted all of its EBIT to debt repayments. The time interest earned ratio indicates that the company has excess or insufficient debt.
When the ratio is less than 1 means that the company has less than $1 of the operating profit to pay each dollar of interest expenses, and vice versa. To put it simply, the company can’t pay for the interest obligations because the annual interest expenses in more than the operating profit.
TIE Ratio for Investors
Investors use the time interest earned ratio to measure how easy for the company to pay off its debt such as a long-term loan or an account payable from the current income to determine the company’s creditworthiness.
When used the time interest earned ratio consistently, the TIE ratio report can reveal trends and provide insight into whether a company needs to overhaul internal processes to remain solvent or whether it is at risk of bankruptcy.
Further, the higher the time interest earned ratio, the more equity and less debt the company uses to finance the company’s assets. So, the low levels of the company’s debt will dilute the return to stockholders due to increased use of equity and not taking advantage of the tax deductibility by interest expense.
Although, companies don’t need to repay their debts multiple times, but the interest earned time ratio shows how financially sound they are and whether they can still invest in their operations after the debt is repaid. While the company doesn’t have to pay off your debts multiple times, a higher ratio indicates that the company has more income.
Time Interest Earned Ratio Formula
Time interest earned ratio can be calculated by dividing the earnings before interests and taxes (EBIT) by the annual interest expenses, or the following time interest earned ratio formula:
TIE = EBIT / Interest expenses
Where:
- EBIT is income before interests and taxes, also known as the operating profit.
- Interest is annual interest expenses (and other fixed charge obligations).
For example, the company had earnings before interests and taxes of $100,000 and had annual interest expenses of $40,000.
TIE = 100,000 / 40,000 = 2.5 times
The example company’s time interest earned ratio is 2.5 times. In other words, the company’s earnings before interests and taxes in more than the interest obligations for 2 times.
Frequently Asked Questions
The time interest earned ratio is a financial ratio that comparison between the earnings before interests and taxes and the interest expense within a year. The ratio measures the number of available incomes for interest payments.
Time interest earned ratio can be calculated by dividing the earnings before interests and taxes (EBIT) by the annual interest expenses as the following formula: TIE ratio = EBIT / Interest expenses
The higher the time interest earned ratio, the more equity and less debt the company uses to finance the company’s assets.
