There is no substantive difference between the interest coverage ratio and times interest earned (TIE); these are two names for the same measurements of business solvency. Coverage ratios, similar to liquidity ratios, express the ability of a firm to meet certain financial obligations. Investors use coverage ratios to track changes in company debt over time and as a tool of comparison among like companies. Lenders pay close attention to coverage ratios before granting further credit or assigning risk profiles to businesses. One common method of expressing debt relationships is the (TIE) or interest coverage ratio.

TIE can be calculated by dividing total interest payable from the earnings before interest, taxes, depreciation and amortization (EBITDA). EBITDA is an accounting category used to assess financial performance. For simplicity's sake, you may often see TIE calculated using earnings before interest and tax (EBIT) rather than EBITDA.

EBIT, EBITDA and total interest payable can be found within a company's income statement. You may see EBIT expressed as operating income. A ratio of 1 suggests that there is sufficient cash flow to pay off interest expenses on debt, but nothing else; a ratio of 5 shows that the company earns five times as much as it has to pay out in interest.

Higher values are generally considered to be more favorable than lower values. There is a point of diminishing value, however, for publicly traded companies; a TIE ratio that is too high may be an indication that the company is under-utilizing debt, limiting possible shareholder equity. Ostensibly, a company could yield greater returns, borrowing at a lower cost of capital than what it currently pays on its debts.

As a general rule, creditors worry when an interest coverage ratio falls beneath 2.5 or 3. Interest coverage ratios tend to vary among different industries, so it is most useful to compare similar competitors. It is common practice to create trendlines of TIE for a company to see year-to-year fluctuations in its ability to service its debts. If the interest coverage ratio for a company seems significantly out of line with either its historical average or the normal range for its industry, this could be a red flag.

There are limitations to any coverage ratios, including TIE. EBITDA and EBIT ignore changes in working capital, capital expenditures, taxes and interest. This is why coverage ratios are often assessed in conjunction with other financial ratios and with a review of the income statement, balance sheet and statement of cash flows.

Shareholders and bondholders have particular interest in TIE, since they are considered to be creditors of the company. A coverage ratio that is dropping suggests that the company may struggle to meet future debt payments, potentially reducing the stock price and damaging bond valuations.

  1. What is a bad interest coverage ratio?

    Understand how interest coverage ratio is calculated and what it signifies, and learn what market analysts consider to be ... Read Answer >>
  2. What is a good interest coverage ratio?

    Learn the importance of the interest coverage ratio, one of the primary debt ratios analysts use to evaluate a company's ... Read Answer >>
  3. Which types of coverage ratios should I look at when deciding to invest in a company?

    Find out why coverage ratios are useful for investors to know and which three coverage ratios an investor should understand ... Read Answer >>
  4. What's the difference between the coverage ratio and the levered free cash flow to ...

    Learn the differences between the equity evaluation metric, the levered free cash flow to enterprise value ratio and various ... Read Answer >>
  5. What does a high times interest earned ratio signify with regard to a company's future?

    Learn how the times interest earned ratio affects the perception of solvency of a company, and what a high ratio can mean ... Read Answer >>
Related Articles
  1. Investing

    How to Calculate a Coverage Ratio

    In broad terms, the higher the coverage ratio, the better the ability of the enterprise to fulfill its obligations to its lenders.
  2. Investing

    An Introduction To Coverage Ratios

    Interest coverage ratios help determine a company's ability to pay down its debt.
  3. Investing

    Analyzing AT&T's Debt Ratios in 2016 (T)

    Learn about AT&T Inc. and its key debt ratios, such as the debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio.
  4. Investing

    Analyzing General Electric's Debt Ratios in 2016 (GE)

    Evaluate GE's debt picture using the most important metrics for a large-cap conglomerate, including the debt-to-equity (D/E) ratio and the interest coverage ratio.
  5. Investing

    Analyzing Wal-Mart's Debt Ratios in 2016 (WMT)

    Analyze Wal-Mart's debt-to-equity ratio, interest coverage ratio and cash flow-to-debt ratio to evaluate the company's financial health and debt management.
  6. Investing

    Interest Coverage Ratio

    Debt in an important factor to remember when analyzing a company's financial health. The interest coverage ratio serves to determine how easily a company can pay interest on outstanding debt. ...
  7. Investing

    4 Leverage Ratios Used In Evaluating Energy Firms

    Analysts use specific leverage ratios to compare firms within an industry. A basic understanding of these ratios helps when evaluating oil and gas stocks.
  8. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  9. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
  1. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ...
  2. Fixed-Charge Coverage Ratio

    A ratio that indicates a firm's ability to satisfy fixed financing ...
  3. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  4. Liquidity Ratios

    A class of financial metrics that is used to determine a company's ...
  5. Accounting Ratio

    A way of expressing the relationship between one accounting result ...
  6. EBITDA to sales ratio

    A financial metric used to assess a company's profitability by ...
Hot Definitions
  1. Time In Force

    Time in force is a special instruction used when placing a trade to indicate how long an order will remain active before ...
  2. Retirement Planning

    Retirement planning is the process of determining retirement income goals and the actions and decisions necessary to achieve ...
  3. Drawdown

    The peak-to-trough decline during a specific record period of an investment, fund or commodity. A drawdown is usually quoted ...
  4. Inverse Transaction

    A transaction that can cancel out a forward contract that has the same value date.
  5. Redemption

    The return of an investor's principal in a fixed income security, such as a preferred stock or bond; or the sale of units ...
  6. Solvency

    The ability of a company to meet its long-term financial obligations. Solvency is essential to staying in business, but a ...
Trading Center