In this article you will see, what is Times Interest Earned Ratio, the formula of TIE and a real example which shows how you can calculate this and how does it matter for your business or any startup?
So, let’s begin,
What is the times interest earned ratio?
The Times Interest Earned Ratio (TIE) is one of the tools from ratio analysis that shows, how easily a company can pay its interest or debt obligations on the basis of its current earnings. The times interest earned ratio is also known as the Interest Coverage Ratio.
Also, this ratio is one of the decisive parameters for the investors or financial institutes to check the credibility of the business before giving the loans or invest money in a particular business.
More the times Interest Earned (TIE), more comfortably and efficiently a company can pay its interest. And less TIE more the negative times interest earned.
Let’s understand the defined formula to calculate the times interest earned ratio;
The formula of Time Interest Earned
To calculate the times interest earned ratio you need only two figures from your P&L statement (profit & loss statement). These are,
- Total Interest Payable
EBIT = Net income + Income Taxes + Total Interest Exp.
Let’s take the real example to see how it can be calculated,
Example & calculation of TIE
Here we will take an example of Amazon.com to know how to calculate the TIE,
Income Statement / P&L Statement of Amazon.com of the FY 2018
To see the full income statement click here.
As per the income statement, the EBIT is $12,717 million (given in the 5th row) and the interest payable is $1,417 million (given in the 9th row). So, the calculation of times interest earned ratio of Amazon.com is,
So, the TIE ratio of Amazon says, this company can pay it’s interest expense 8.5 times from its earnings.
It is as simple as that!:)
But you may think, how the TIE / Coverage ratio is matters? or why should we give importance to this?
How Times Interest Earned Matters?
Of course, TIE matters a lot. Especially for those companies who are willing to raise or already raised the funds through debts or also from equity.
We will understand the importance of the Times interest earned ratio (TIE) in a practical way. So that you can relate this to your business and realize it’s importance very easily.
Suppose you are an investor and you have three options to invest,
- A company called ‘A‘ has TIE less than 1 (to be exact 0.80).
- A second company called ‘B‘ has TIE exactly 1.
- And a third company ‘C‘ has TIE more that 1.5.
So here is a question for you,
In which company you would like to invest from A/B/C?
The answer is: The pro-investor will prefer to invest in C from the given three.
Company A has TIE less than 1 so it can’t even pay its interest on the debt it has and somewhere it is losing its money.
Company B has TIE 1 so it has sufficient funds to pay its interest on the debt. So, company B is better than A but still, it’s not doing well. Because this company is able to pay only the interest, not the principal amount. So this company will get into trouble when the principal amount will be due.
But the company ‘C‘ has TIE more that 1.5. This means this company is doing well and it is playing more safely than A&B. Because this company is earning more than it’s interest payable. So it may able to pay it’s principal amount too when it will come to pay the principal amount.
Generally, the analysts or the investors consider that, if the company has TIE 3 or more than 3 then it is performing beyond the mark.
So, all in all, it mainly matters for the investors or for the financial institutions to judge the performance of your company.
So, Times Interest Earned ratio is nothing but an analytical term that shows the ability of a company to pay back its loans or ultimately how profitable it is.
And as a suggestion to the business people, I will say, no matter the company has to or hasn’t to show their performance to any third party for any purpose, every CEO, entrepreneur or the initiator in the company should keep his control on this important parameter to keep the company’s financials healthy and safe.
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