Times Interest Earned (TIE)

Times interest earned (TIE) is a financial ratio that measures a company's ability to meet the interest payments on its debt out of its operating profit. It is calculated by dividing earnings before interest and taxes, or EBIT, by interest expense for the same period. A result of 5 means the company earned five times the interest it had to pay. The higher the ratio, the larger the cushion before falling profits would leave the company unable to pay its lenders.

The ratio is one of the standard solvency measures taught in financial statement analysis. In practice it is one version of the broader interest coverage ratio, a family of measures that also includes versions based on EBITDA or operating cash flow. Lenders, bondholders and credit rating agencies use it to judge default risk, and many loan agreements set a minimum level as a covenant.

The standard calculation is:

• $\text{EBIT}$ is earnings before interest and taxes, usually taken as operating income, or as net income plus interest expense plus income tax expense.
• $\text{Interest expense}$ is the interest charged for the period on all borrowings, including amortization of bond discount or premium, as reported on the income statement.

EBIT is used rather than net income because interest is paid before tax and is deductible, so the full pre-tax operating profit is available to pay it.

A distribution company reports net income of $4,200,000, income tax expense of $1,300,000 and interest expense of $1,500,000 for the year. EBIT is $4,200,000 plus $1,300,000 plus $1,500,000, or $7,000,000. Times interest earned is $7,000,000 divided by $1,500,000, or about 4.7 times.

Suppose the company then borrows another $20 million at 7 percent to fund an acquisition, adding $1,400,000 of annual interest, and the acquisition adds $1,000,000 to EBIT. The ratio becomes $8,000,000 divided by $2,900,000, or about 2.8 times. Profit has grown, but the cushion has narrowed considerably, and a 20 percent fall in EBIT would now bring the ratio to about 2.2 times. If the company's loan agreement requires a minimum of 3.0, it would already be in breach.

• A ratio below 1.5 is usually a warning sign: a modest fall in profit could leave the company unable to pay interest from earnings.
• Ratios of 3 to 5 are often considered adequate for established companies, though acceptable levels vary by industry.
• Stable businesses such as utilities can operate safely with lower ratios than cyclical ones such as airlines or construction, whose profits swing widely.
• A very high ratio may suggest the company is using little debt and could borrow more cheaply than it raises equity.

Analysts track the trend over several years, and read the ratio alongside the debt-to-equity ratio and the debt service coverage ratio, which also includes principal repayments.

Times interest earned uses accounting profit, not cash. A company with high EBIT but weak cash collection may still struggle to pay interest, so analysts often compare it with a cash-based coverage measure. The ratio ignores principal repayments, lease payments and other fixed charges, which is why some lenders prefer a fixed charge coverage ratio. EBIT can be inflated by one-off gains or depressed by one-off charges, so adjusted figures are often used. Capitalized interest, which is added to the cost of assets under construction rather than expensed, may also need to be added back to interest expense to show the full burden. Finally, a single year's ratio can be misleading for cyclical businesses; looking at it across a full economic cycle gives a better picture of default risk.