Definition of Times Interest Earned Ratio
The times interest earned ratio is an indicator of a corporation’s ability to meet the interest payments on its debt. The times interest earned ratio is calculated as follows: the corporation’s income before interest expense and income tax expense divided by its interest expense.
The larger the times interest earned ratio, the more likely that the corporation can make its interest payments.
The times interest earned ratio is also referred to as the interest coverage ratio.
Example of Times Interest Earned Ratio
Assume that a corporation had the following amounts for the most recent year:
- Net income after tax of $500,000
- Interest expense of $200,000
- Income tax expense of $300,000
Given these assumptions, the corporation’s income before interest and income tax expense was $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 ratio was 5 ($1,000,000 divided by $200,000).
