What is Times Interest Earned Ratio?
The Times Interest Earned Ratio (TIE) measures a company’s ability to service its interest expense obligations based on its current operating income.
Otherwise known as the interest coverage ratio, the TIE ratio helps measure the credit health of a borrower. As a general rule of thumb, the higher the times interest earned ratio, the more capable the company is at paying off its interest expense on time.
How to Calculate Times Interest Earned Ratio (Step-by-Step)
The times interest earned ratio (TIE) compares the operating income (EBIT) of a company relative to the amount of interest expense due on its debt obligations.
Conceptually identical to the interest coverage ratio, the TIE ratio formula consists of dividing the company’s EBIT by the total interest expense on all debt securities.
Times Interest Earned Ratio Formula (TIE)
The formula for calculating the times interest earned (TIE) ratio is as follows.
The resulting ratio shows the number of times that a company could pay off its interest expense using its operating income.
Alternatively, other variations of the TIE ratio can use EBITDA as opposed to EBIT in the numerator.
How to Interpret Times Interest Earned Ratio (High or Low)
As a general rule of thumb, the higher the TIE ratio, the better off the company is from a risk standpoint.
- Higher TIE Ratio → The company likely has plenty of cash to service its interest payments and can continue to re-invest into its operations to generate consistent profits. If a company has a high TIE ratio, this signifies its creditworthiness as a borrower and the capacity to withstand underperformance due to the ample cushion (to satisfy its debt obligations) provided by its cash flows.
- Low TIE Ratio → On the other hand, a lower times interest earned ratio means that the company has less room for error and could be at risk of defaulting. Companies with lower TIE ratios tend to have sub-par profit margins and/or have taken on more debt than their cash flows could handle.
What is a Good TIE Ratio?
While there aren’t necessarily strict parameters that apply to all companies, a TIE ratio above 2.0x is considered to be the minimum acceptable range, with 3.0x+ being preferred.
But once a company’s TIE ratio dips below 2.0x, it could be a cause for concern – especially if it’s well below the historical range, as this potentially points towards more significant issues.