Calculating TIE Interest Ratio

by Nicole Crawford

A company's times interest earned (TIE) ratio is one of the important indicators of its financial status. TIE ratio is also known as "interest coverage ratio" and "fixed-charged coverage." A low ratio means that a company may not be able to meet its financial obligations, and is considered to be one of the signs of upcoming financial distress and even bankruptcy.

Identification

Times interest earned measures how many times a company can meet its required income payments. The calculation uses pretax figures rather than net-income information, since interest payments are paid from pretax income. The times interest earned ratio also indicates how far a company can decline before it is unable to meet interest payments. As noted in the book "Fundamentals of Financial Management," the TIE ratio is important because failure to pay interest can cause legal action from creditors and may even lead to bankruptcy.

Formula

To calculate a company's TIE ratio, you will need two figures: the company's earnings before interest and taxes and the total amount of interest owed on bonds and other sources of contractual debt. To perform the calculation, simply divide the earnings by the interest owed. For example, if a company's total earnings were $30,000 and their interest owed was $10,000, their TIE ratio would be 3, or 3:1. This means that they produce enough profit to cover their interest payments three times.

Interpretation

The industry-average TIE ratio is 6.0, according to "Financial Management Theory and Practice." A ratio lower than 2.5 is considered to be a warning sign of financial troubles. However, as noted by Investopedia, a high TIE ratio can also be interpreted as a negative sign, since it may indicate a lack of desirable debt. A high TIE ratio may also indicate that a company is investing too much money in paying off debt at the expense of other projects that might improve its overall performance.

Considerations

As with other financial-analysis tools, TIE ratios should never be considered in isolation from other variables. The TIE ratio is only one of many debt-management ratios, which also include the debt ratio, which measures the ratio of liabilities and assets, and the EBITDA coverage ratio, which accounts for more of a given company's cash flow as well as liabilities than the TIE ratio does. In addition to debt-management ratios, figures such as asset-management and profitability ratios should also be considered.

References

About the Author

Nicole Crawford is a NASM-certified personal trainer, doula and pre/post-natal fitness specialist. She is studying to be a nutrition coach and RYT 200 yoga teacher. Nicole contributes regularly at Breaking Muscle and has also written for "Paleo Magazine," The Bump and Fit Bottomed Mamas.

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