Loading the player...

What is 'Times Interest Earned - TIE'

Times interest earned (TIE) is a metric used to measure a company's ability to meet its debt obligations. The formula is calculated by taking a company's earnings before interest and taxes (EBIT) and dividing it by the total interest payable on bonds and other contractual debt. TIE indicates how many times a company can cover its interest charges on a pretax earnings basis.

BREAKING DOWN 'Times Interest Earned - TIE'

Failing to meet these obligations could force a company into bankruptcy. TIE is also referred to as the interest coverage ratio.

Generating cash flow to make principal and interest payments and avoiding bankruptcy depends on a company's ability to produce earnings. A company's capitalization refers to the amount of money it has raised by issuing stock or debt, and choices about capitalization impact the TIE ratio. Businesses consider the cost of capital for stock and debt, and they use that cost to make decisions about capitalization.

How to Calculate Times Interest Earned (TIE)

Assume, for example, that XYZ Company has $10 million in 4% debt outstanding and $10 million in common stock, and that the firm needs to raise more capital to purchase equipment. The cost of capital for issuing more debt is an annual interest rate of 6%, and shareholders expect an annual dividend payment of 8%, plus appreciation in the stock price of XYZ. The business decides to issue $10 million in additional debt, and the firm determines that the total annual interest expense is: (4% X $10 million) + (6% X $10 million), or $1 million annually. The company's EBIT calculation is $3 million, which means that the TIE is 3, or three times the annual interest expense (interest payable).

Factoring in Consistent Earnings

Companies that generate consistent annual earnings are more likely to carry more debt as a percentage of total capitalization. If a lender sees a history of generating consistent earnings, the firm is in a better position to make principal and interest payments on time. Utility companies, for example, provide a product that consumers use every month, and these firms generate consistent earnings. As a result, some utility companies may raise 60% or more of their capital from issuing debt.

Startup firms and other businesses that have inconsistent earnings raise most, or all of the company capital using equity – that is, stock. Once a company can establish a track record of producing reliable earnings, it may raise capital through debt offerings and shift away from issuing common stock.

RELATED TERMS
  1. Funded Debt

    A funded debt is a company's debt that will mature in more than ...
  2. Capital Structure

    Capital structure is how a firm funds its operations and growth, ...
  3. Debt Issue

    A debt issue is a financial obligation that allows the issuer ...
  4. Net Debt

    A metric that shows a company's overall debt situation by netting ...
  5. Long-Term Debt

    Long-term debt consists of loans and financial obligations lasting ...
  6. Effective Debt

    The net sum of all of a company's outstanding debt. In addition ...
Related Articles
  1. Investing

    Target Corp: WACC Analysis (TGT)

    Learn about the importance of capital structure when making investment decisions, and how Target's capital structure compares against the rest of the industry.
  2. Investing

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  3. Investing

    4 Leverage Ratios Used In Evaluating Energy Firms

    These four leverage ratios can help investors evaluate how energy manage their debt.
  4. Investing

    Will Corporate Debt Drag Your Stock Down?

    Corporate debt can mean a leg up for firms, or the boot for investors. How to tell the difference.
  5. Investing

    Debt Ratio

    The debt ratio divides a company’s total debt by its total assets to tell us how highly leveraged a company is—in other words, how much of its assets are financed by debt. The debt component ...
  6. Small Business

    Explaining Cost Of Capital

    Cost of capital is the cost of funds used to finance a business.
  7. Investing

    Debt Ratios

    Learn about the debt ratio, debt-equity ratio, capitalization ratio, interest coverage ratio and the cash flow to debt ratio.
  8. Investing

    Key Financial Ratios to Analyze Investment Banks

    Find out which financial ratios are most useful when analyzing an investment bank, and why tracking capital efficiency is especially important.
  9. Investing

    Lowe's Stock: Capital Structure Analysis (LOW)

    Examine Lowe's Companies' equity capitalization, debt capitalization and enterprise value to analyze trends in the retailer's capital structure.
RELATED FAQS
  1. How do interest rates influence a corporation's capital structure?

    Learn about how changing interest rates can affect a corporation's capital structure because of their impact on the cost ... Read Answer >>
  2. If a company has a high debt to capital ratio, what else should I look at before ...

    Learn about some of the financial leverage and profitability ratios that investors can analyze to supplement examining the ... Read Answer >>
  3. What are the most common leverage ratios for evaluating a company?

    Learn more about some of the most common leverage ratios used by traders to determine whether a company is using debt in ... Read Answer >>
  4. How does a company choose between debt and equity in its capital structure?

    Learn about the benefits and drawbacks of debt and equity financing. Find out how to compare capital structures using cost ... Read Answer >>
  5. Why would a company use a form of long-term debt to capitalize operations versus ...

    Learn about the different consequences of using long-term debt versus equity to raise capital for business activity, and ... Read Answer >>
Hot Definitions
  1. Price-Earnings Ratio - P/E Ratio

    The Price-to-Earnings Ratio or P/E ratio is a ratio for valuing a company that measures its current share price relative ...
  2. Internal Rate of Return - IRR

    Internal Rate of Return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments.
  3. Limit Order

    An order placed with a brokerage to buy or sell a set number of shares at a specified price or better.
  4. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations.
  5. Return on Investment (ROI)

    Return on Investment (ROI) is a performance measure used to evaluate the efficiency of an investment or compare the efficiency ...
  6. Interest Coverage Ratio

    The interest coverage ratio is a debt ratio and profitability ratio used to determine how easily a company can pay interest ...
Trading Center