Times Interest Earned

From Financial Literacy Wiki

Times interest earned (TIE) or interest coverage ratio is a measure of a company's ability to honor its debt payments. It may be calculated as either EBIT or EBITDA divided by the total interest payable.

Times Interest Earned or Interest Coverage is a tool to measure a company's ability to meet its debt obligations. When Interest Coverge is less then 1x, the Company is not generating enough cash from its operations EBITDA to meet its interest obligations. The company would then need to use cash or raise funds to meet the obligations.

General rule of thumb of 2.5x is prefered, meaning if all else remains the same, the cash generated from operations can cover 2.5 times of the interest obligations.

However, a high ratio can indicate that a company has an undesirable low level of debt or is paying down too much debt with earnings that could be used for other projects. The rationale is that a company would yield greater returns by investing its earnings into other projects and borrowing at a lower cost of capital than what it is currently paying for its current debt.