The times interest earned ratio is an indicator of a company's ability to meet the interest payments on its debt. The times interest earned calculation is a corporation's income before interest and income tax expense, divided by interest expense.
To illustrate the times interest earned ratio, let's assume that a corporation's net income after tax was $500,000; its interest expense was $200,000; and its income tax expense was $300,000. Given these assumptions, the corporation's income before interest and income tax expense is $1,000,000 (net income of $500,000 + interest expense of $200,000 + income tax expense of $300,000). Since the interest expense was $200,000, the corporation's times interest earned is 5 ($1,000,000 divided by $200,000).
The higher the times interest earned ratio, the more likely it is that the corporation will be able to meet its interest payments.
The times interest earned ratio is also referred to as the interest coverage ratio.
View Our Course Outline