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Times Interest Earned Definition, Meaning & Formula

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What Is the Interest Earned Ratio in Times?

Times Interest Earned : The TIE ratio is a measure of a company’s capacity to meet debt commitments based on current income.

Earnings before interest and taxes (EBIT) divided by total interest payable on bonds and other debt is the formula for calculating a company’s TIE number.

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The outcome is a number that indicates how many times a company’s pretax earnings could pay its interest charges.

TIE (Times Interest Earned) Ratio

times interest earned

The interest coverage ratio is also known as the TIE.

Points to remember:

The TIE of a corporation reveals its ability to repay its debts.

A higher TIE score indicates that a corporation has sufficient cash after paying its obligations to continue investing in the business.

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TIE is computed by dividing earnings before interest and taxes by total interest payable on debt.

The TIE (Times Interest Earned) Ratio: An Overview

Obviously, no business needs to pay off its debts multiple times in order to stay afloat.

The TIE ratio, on the other hand, is a measure of a company’s relative debt-free status.

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Having enough cash flow to keep investing in the business is preferable to simply having enough money to avoid bankruptcy.

A company’s capitalization is the amount of money it has raised through the sale of stock or the issuance of debt, and these decisions have an impact on its TIE ratio.

Businesses factor on the cost of capital for stock and debt while making choices.

How to Work Out the Number of Times Interest Has Been Earned (TIE)

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Consider the following scenario: XYZ Company owes $10 million in 4% debt and $10 million in common stock.

To buy equipment, the company needs to raise more money. An annual interest rate of 6% is the cost of capital for issuing more debt.

The company’s stockholders anticipate an annual dividend payment of 8%, as well as a rise in XYZ’s stock price.

The company decides to issue an additional $10 million in debt.

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The total annual interest expense will be $4 million (4 percent x $10 million) + $6 million (6 percent x $10 million), or $1 million. The EBIT of the company is $3 million.

This suggests that XYZ Company’s TIE ratio is three times its annual interest expense.

Consistent Earnings are taken into account

Companies with steady annual earnings are more likely to have higher debt levels as a percentage of total capitalization.

A lender will consider a company to be a better credit risk if it has a history of generating consistent earnings.

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Utility firms, for example, have a steady profit stream. Consumers and enterprises do not have the choice of skipping out on their goods.

Debt is used by some utility businesses to raise 60% or more of their capital.

Startups and businesses with fluctuating earnings, on the other hand, raise the majority of their capital via issuing shares.

Once a company has established a track record of producing consistent earnings, it may consider debt issues as a means of obtaining funds.

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