Interest Coverage Ratio or Times Interest Earned Ratio Formula and Calculation

Times interest earned ratio, which is also commonly called as interest coverage ratio indicates whether the business is able to cope with its debt obligation, i.e. whether the business earns enough operating profit to be able to pay interest on borrowed financial means. The following formula is used:

Interest Earned Ratio=EBIT (Earnings before Interest and Tax)/Interest Expenses

Interest coverage ratio indicates how many times Earnings before Interest and Tax (EBIT) can cover interest expenses of the business for the borrowed financial means.

The rule is that the business must be able to generate sufficient profits from its main activities to be able to meet its financial liabilities.

All the data for this ratio calculation can be derived from the Income Statement (you can check sample Income Statement for more clarity).

The result of times interest earned ratio will be expressed in times, not percentage and will indicate how many times EBIT covers interest expenses.

Also what is essential to understand that EBIT from the Income Statement is obtained by using accrual accounting method, which would mean that revenues are recognized while earned and expenses are recognized if they are related to the revenues earned, without taking into account the actual receipt or spending of cash. Therefore to see the full picture of the business ability to generate enough cash to pay its financial debts, it is recommended to analyse cash flow statement also and check whether the business generates enough cash from operating activities.

Make sure you also check other financial ratios: Return on Assets Ratio, Inventory Turnover Ratio.

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