Times interest earned (TIE) ratio

Times interest earned (TIE) ratio shows how many times the annual interest expenses are covered by the net operating income (income before interest and tax) of the company. It is a long-term solvency ratio that measures the ability of a company to pay its interest charges as they become due.Times interest earned ratio is known by various names such as debt service ratio, fixed charges cover ratio and Interest coverage ratio. The ratio is expressed in times.

Formula:

Times interest earned ratio is computed by dividing the income before interest and tax by interest expenses. The formula is given below:

times-interest-earned-ratio-img1

Income before interest and tax (i.e., net operating income) and interest expense figures are available from the income statement.

Example:

A creditor has extracted the following data from the income statement of PQR  and requests you to compute and explain the times interest earned ratio for him.

times-interest-earned-ratio-img2

Required: Compute times interest earned (TIE) ratio of PQR company.

Solution:

= (2,570 / 320)

= 8.03 times

The times interest earned ratio of PQR company is 8.03 times. It means that the interest expenses of the company are 8.03 times covered by its net operating income (income before interest and tax).

Significance and Interpretation:

Times interest earned ratio is very important from the creditors view point. A high ratio ensures a periodical interest income for lenders. The companies with weak ratio may have to face difficulties in raising funds for their operations.

Generally, a ratio of 2 or higher is considered adequate to protect the creditors’ interest in the firm. A ratio of less than 1 means the company is likely to have problems in paying interest on its borrowings.

A very high times interest ratio may be the result of the fact that the company is unnecessarily careful about its debts and is not taking full advantage of the debt facilities.

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15 Comments on Times interest earned (TIE) ratio

  1. temba

    Question: A company faces total interest charges of $10,000 per year, annual sales of $1,000,000, a tax rate of 40 percent, and a net profit of 60 percent. What is the company’s times interest earned ratio?

  2. Zooki

    If 60 percent profit is before interest and tax, your problem can be solved as follows:

    Net profit before interest and tax = $1,000,000 × 0.6 = $600,000

    According to above formula, the ratio is computed by dividing profit before interest and tax by interest expenses for the period. The ratio would therefore be computed as follows:

    Times interest earned ratio = 600,000/10,000 = 60 times

  3. afi123

    Calculating the Times Interest Earned Ratio For the most recent year, Back Alley Boys, Inc., had sales of $250,000, cost of goods sold of $80,000, depreciation expense of $27,000, and additions to retained earnings of $33,360. The firm currently has 20,000 shares of common stock outstanding, and the previous year’s dividends per share were $1.50. Assuming a 34% income tax rate, what were the times interest earned ratio?

  4. Accounting For Management

    afi123! you need to find out income before interest and tax and the interest expenses of the firm to apply the times interest earned ratio formula. These two figures are computed below:

    Income before interest and tax (IBIT):
    = Sales – COGS – Depreciation
    = $250,000 – $80,000 – $27,000
    = $143,000

    Income before tax (IBT):
    = Additions to retained earnings + dividends
    = ($33,360 + $30,000)/0.66
    = $96,000
    The sum of the additions in retained earnings and the amount of dividends have been divided by 0.66 to arrive at income before tax (IBT).

    The annual Interest expense:
    = IBIT – IBT
    = $143,000 – $96,000
    = $47,000

    Times interest earned ratio (TIER):
    = $143,000/$47,000
    = 3.04 times

  5. rachna

    From where 0.66 is came plz describe me. in previous question

  6. Accounting For Management

    Hi Rachna,

    The tax rate given in the question is 34%. If company pays 34% tax on its taxable income, the income after tax would be 66% or 0.66 (100% – 34%). Another way to express this relationship is as follows:
    Income after tax = Income before tax – Income tax
    66% = 100% – 34%
    or
    .66 = 1 – .34

    Hope this helps.

  7. shahbaz Ali

    in case of loss how can we calculate the time interest ratio??? plz tell me any one???

  8. daniel patrick

    Thank you all.

  9. Lorie

    What does the times means? Is it times per year or times is equivalent to years?

  10. Accounting For Management

    @Lorie
    If ratio is 4, it means income before interest and tax is 4 times bigger than the annual interest expenses.

  11. Lynn

    This information has been most helpful, I just hope that I have gotten the understanding to do my final paper with. Thanks everyone for the contribution.

  12. Mrinmayee

    Hi,
    Does the formula need any adjustment if EBIT is negative?

  13. Kishor

    Suppose,A has a TIE ratio of 4 & B has a TIE ratio of 7, which one is better & how can I explain this as interpretation?

  14. Boitumelo Medupe

    I have been presented with the following information about XYZ Ltd.
    Total equity is 8%
    ROA is 20%
    Total asset turnover is 6 times.

    Determine the ROE for XYZ Ltd

  15. Sija

    Can someone please help me?
    If I have an income statement with financial income, do I include that in the interest expenses?
    Thank you

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