Times Interest Earned Formula

Times Interest Earned Formula (Table of Contents)

Times Interest Earned Formula
Examples of Times Interest Earned Formula (With Excel Template)
Times Interest Earned Formula Calculator

Times interest earned coverage ratio is calculated by dividing the earnings before interest and taxes (operating profit) by the interest expenses. Interest expenses are the total interest payable on the total debt by the company in the balance sheet. The EBIT is reported in the income statement and comes after EBITDA and deducting depreciation. Total interest expense is reported in the income statement during quarterly or annual filings by the companies.

Times Interest Earned Formula:

Times Interest Earned = EBIT / Interest Expenses

Examples of Times Interest Earned Formula (With Excel Template)

Let’s take an example to understand the calculation of Times Interest Earned formula in a better manner.

Times Interest Earned Formula – Example #1

Suppose for a company the quarterly EBIT is Rs350 crore and the total interest expense for the company is Rs 50 crore then calculate the times interest earned ratio for the company.

Solution:

Times Interest Earned ratio is calculated using the formula given below

Times Interest Earned = EBIT / Interest Expenses

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Times Interest Earned = 350 / 50
Times Interest Earned = 7

Times interest earned ratio of 7 signifies that the company is able to generate operating profit which is seven-time over the total interest liability for the period. Lenders and investors who are analyzing the company are always looking for a higher ratio. As a lower ratio signifies that the company is facing a liquidity crisis which in turn can also lead to a solvency crisis for the company.

Times Interest Earned Formula – Example #2

Below is the snapshot of quarterly result for reliance industries. We can see that the operating profit or EBIT for industries for a quarter is Rs 17341 crore. And the interest expense or finance cost for the period is Rs 4,119 crore. Calculate the times interest earned ratio for the company.

Source: http://www.ril.com/getattachment/8aa9eb29-fa77-4555-8056-7998b7e1159b/Financial%20performance%20for%20the%20quarter/nine%20months%20ended%2031%20Dec,%202018.aspx

Solution:

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Times Interest Earned ratio is calculated using the formula given below

Times Interest Earned = EBIT / Interest Expenses

Times Interest Earned = 17341 / 4119
Times Interest Earned = 4.21

This signifies that the company is able to generate operating profit which is four time over the total interest liability for the period.

Times Interest Earned Formula – Example #3

Below is the snapshot of quarterly result for Tata Steel. We can see that the operating profit or EBIT for industries for quarter is Rs 5800 crore. And the net interest expense or finance cost for the period is Rs 1116 crore. Calculate the times interest earned ratio for the company.

Source: https://www.tatasteel.com/media/6351/q3fy18results.pdf

Solution:

Times Interest Earned ratio is calculated using the formula given below

Times Interest Earned = EBIT / Interest Expenses

Times Interest Earned= 5800 / 1116
Times Interest Earned = 5.20

This signifies that the company is able to generate operating profit which is five time over the total interest liability for the period.

You can download this Times Interest Earned Template here – Times Interest Earned Formula Excel Template

Explanation of Times Interest Earned Formula

Times interest earned formula also known popularly as the interest coverage is a ratio to determine how much a company earns operating profit in order to cover the interest expenses for the company. Interest expense is a liability for the company which the company needs to pay to its lenders, whom lend the company money in order to expand the business. Most part of the interest expense is due to long term debt of the company that why this ratio is also considered as the solvency ratio as it signifies whether the company is solvent enough to pay the debt. If the company is not able to generate enough operating profit to pay off the interest then the debt holders can ask the company to file for bankruptcy and sell their assets in order to pay the debt to the debt holders. Creditors look for higher ratio which signifies that the company is covering the interest payment with its operating income generated through normal course of the business. The ratio I not represented in the form of a percentage, it is represented in the form of an absolute number in order to find out by how many time the operating profit covering the interest cost.

Relevance and Uses of Times Interest Earned Formula

Times interest earned formula is one of the most important formulas for the creditors in order to find out the credit health of a company. It shows how many times the operating profit of a company from its business operations is able to cover the total interest expense for the company in a given period of time. Times interest earned ratio is a kind of solvency ratio as the major part of the total interest come from long term debt for the company. This ratio helps the lenders to judge whether the company will be to repay their debt also service their interest from the normal course of the business. From the example above for reliance industries we can see that the times interest earned ratio for the company is 4. It signifies that the company is able to generate four times more operating income in comparison to the amount of interest it needs to pay to the lenders. Creditors or investors of a company look for this ratio whether the ratio is high enough for the company. Higher the ratio better it is from the perspective of the lenders or the investors. A lower ratio will signify both liquidity issues for the firm and also in some cases it may also lead to solvency issues for a company. If the company do not earn enough operating income from the normal courses of the business, then it will not be able to repay the interest of the debt. In that case it will have liquidity crunch and may need to sell its assets or may take up more debt in order to service the interest component of the previous debts. This will eventually lead to impacting the business and can lead to solvency crisis for the company.