Times Interest Earned Ratio: How to Calculate TIE Ratio

The times interest earned ratio—commonly known as the TIE ratio or interest coverage ratio—compares a company’s earnings before interest and taxes (EBIT) to its total interest expenses. TIE ratios appear on financial statements to illustrate how much of a company’s income goes toward servicing long-term debt.

If a company’s operating income cannot cover its annual interest expenses, it may mean the business is a credit risk that could default on future debt payments. When balance sheets show that a company can meet its debt obligations using its normal cash flow, it speaks well of the company’s ability to remain in business.

As financial ratios go, the TIE ratio is relatively simple to calculate. The ratio formula is:

Times Interest Earned Ratio = Earnings Before Interest and Taxes / Total Interest Expenses

A business’s earnings before interest and taxes, or EBIT, represents the net income after salaries and short-term liabilities are paid off but before interest payments and taxes are paid. It’s possible for a company's times interest earned ratio to fluctuate from one financial reporting period to the next because a company's income may fluctuate from one income statement to the next. What's more, a lender's interest rates can rise and fall with market conditions, and these fluctuating interest charges can also cause the TIE ratio to change.

The times interest earned ratio can provide a measure of a company’s overall solvency. Investment bankers and lenders use the TIE ratio (and other solvency ratios) to determine whether a company can use its current income to shoulder additional debt or whether it needs to quickly ramp up profits and improve liquidity.

Many investors look for a TIE ratio greater than 2.5. A TIE ratio of 2.5 means that a company’s earnings exceed their interest expenses by two and a half times. A rate lower than 2.5 could indicate that the company has overextended.

A high times interest earned ratio indicates healthy profitability for companies. Companies with higher ratios can handle debt repayment without sapping their income streams. This bodes well for long-term solvency. If a company’s TIE ratio is very high, however, it may indicate that the company has not invested much in growth.

If a company’s EBIT and total interest expenses are of identical amounts, its times interest earned ratio will equal one. This means the company’s net income (before taxes and regular interest payments) just barely meets the minimum threshold for covering future interest expenses. Any debt ratio value below one means that future debt obligations exceed a company’s earnings. This can be an ominous sign for future solvency.

A low or negative TIE ratio indicates that debt service may be taking up too much of a company’s operating expenses. If debt payments continually exceed revenue, a company risks missing essential payments on items like salaries, accounts payable, and income tax. While debt is not an inherently bad thing for a growing business, it must eventually dip below the amount of revenue a company brings in.

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