The times interest earned ratio, sometimes called the interest coverage ratio, is a coverage ratio that measures the proportionate amount of income that can be used to cover interest expenses in the future.
In some respects the times interest ratio is considered a solvency ratio because it measures a firm’s ability to make interest and debt service payments.
- Easily assess the solvency of company
- Earnings can be distorted by accounting tactics
The times interest ratio is stated in numbers as opposed to a percentage. The ratio indicates how many times a company could pay the interest with its before tax income, so obviously the larger ratios are considered more favorable than smaller ratios.
In other words, a ratio of 7.96 means that a company makes enough income to pay for its total interest expense 4 times over. Said another way, this company’s income is 7.96 times higher than its interest expense for the year.
As you can see, creditors would favor a company with a much higher times interest ratio because it shows the company can afford to pay its interest payments when they come due. Higher ratios are less risky while lower ratios indicate credit risk.