Accounting Ratios Overview, Examples, Formulas

As a TIE financial ratio example, a company’s TIE ratio is computed as EBIT (earnings before interest and taxes) divided by annual interest expense on debt. The times interest earned ratio (TIE) is calculated as 2.15 when dividing EBIT of $515,000 by annual interest expense of $240,000. The times interest earned ratio (interest coverage ratio) can be used in combination with a net debt-to-EBITDA ratio to indicate a company’s ability for debt repayment. EBITDA is earnings before interest, taxes, depreciation, and amortization. Will your company have enough profits (and cash generated) from business operations to pay all interest expense due on its debt in the next year?

The interpretation is that the company is within its debt capacity with a low risk of not paying interest on its debt. A times interest earned ratio of 2.15 is considered good because the company’s EBIT is about two times its annual interest expense. This means that the business has a high probability of paying interest expense on its debt in the next year. The purpose of the TIE ratio, also known as the interest coverage ratio (ICR), is to evaluate whether a business can pay the interest expense on its debt obligations in the next year.

Times Interest Earned Ratio: What It Is, How to Calculate TIE

Our second example shows the impact a high-interest loan can have on your TIE ratio. Any opinions, analyses, reviews or recommendations expressed here are those of the author’s alone, and have not been reviewed, approved or otherwise endorsed by any financial institution. Review all of the costs you incur, and identify areas where costs can be reduced. If you can purchase a product through multiple suppliers, you can force the suppliers to compete for your business and offer lower prices.

For example, if dividends are $100,000 and income is $400,000, the dividend payout ratio is calculated by dividing $100,000 by $400,000, which is 25%. The higher the dividend payout ratio the higher percentage of income a company pays out as dividends as opposed to reinvesting back into the company. For example, if gross profit is $80,000 and sales are $100,000, the gross profit margin is 80%. The higher the gross profit margin, the better, as it indicates that a company is keeping a higher proportion of revenues as profit rather than expenses.

Times Interest Earned Ratio Explained (Formula + Examples)

As mentioned above, TIE is also referred to as the interest coverage ratio. If earnings are decreasing while interest expense is increasing, it will be more difficult to make all interest payments. Company founders must be able to generate earnings and cash inflows to manage interest expenses. These two liquidity ratios are used to monitor cash collections, and to assess how quickly cash is paid for purchases. Keep in mind that earnings must be collected in cash to make interest payments. While the TIE ratio does not account for cash, managers must collect sufficient cash to make interest payments.

• Another strategy is to use available cash flow to pay down debt faster and eliminate some of your interest expense.
• And companies report interest expense related to operating leases as part of lease expense rather than as interest expense.
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• The higher the ratio, the better, as it indicates how many times a company could pay off its debt with its earnings.
• For example, if you have any current outstanding debt, you’re paying interest on that debt each month.
• While the TIE ratio does not account for cash, managers must collect sufficient cash to make interest payments.

A good TIE ratio is subjective and can vary widely depending on the industry, economic conditions, and the specific circumstances of a company. However, as a general rule of thumb, a TIE ratio of 1.5 to 2 is often considered the minimum acceptable margin for assuring creditors that the company can fulfill its interest obligations. Monitoring the times interest earned ratio can help you make informed decisions about generating sufficient earnings to make interest payments, and decisions about taking on more debt. Rho’s platform is an ideal solution for managing all expenses and payments.

Examples of the times interest earned ratio

Using Excel spreadsheets for calculations is time consuming and increases the risk of error. The TIE’s main purpose is to help quantify a company’s probability of default. This, in turn, helps determine relevant debt parameters such as the appropriate interest rate to be charged or the amount of debt that a company can the times interest earned ratio provides an indication of safely take on. Over 1.8 million professionals use CFI to learn accounting, financial analysis, modeling and more. Start with a free account to explore 20+ always-free courses and hundreds of finance templates and cheat sheets. There are numerous accounting or financial ratio categories available to choose from.