FINANCIAL
STATEMENT ANALYSIS 1-41
Times Interest Earned (TIE) Ratio
The Times Interest Earned Ratio gives the analyst an idea of how far
operating income can decline before the company is unable to meet its
interest payments on currently held debt. The TIE Ratio for XYZ
Corporation is computed by dividing
E
ARNINGS
B
EFORE
I
NTEREST AND
T
AXES
(EBIT)
by the
I
NTEREST
C
HARGES
.
Times Interest Earned
=
(EBIT) / (Interest Charges)
=
($22.5) / ($6.0)
=
3.8 times
Coverage of
interest payments
by earnings
The calculation uses earnings before interest and taxes in the numerator
because interest payments are tax deductible in many countries, and the
ability to pay current interest is not affected by taxes. The TIE Ratio
indicates to the analyst how many times the company can make interest
payments with the earnings generated by the firm.
Fixed Charge Coverage Ratio
Coverage of
interest payments
plus long-term
lease payments
The Fixed Charge Coverage Ratio has one important difference from
the TIE Ratio. Many companies enter long-term lease agreements for
assets. This ratio recognizes those leases as obligations and includes the
L
EASE
P
AYMENTS
as fixed charges along with
I
NTEREST
P
AYMENTS
on
loans. The Fixed Charge Coverage Ratio is computed by dividing
EBIT
plus
L
EASE
P
AYMENTS
by
I
NTEREST
C
HARGES
plus
L
EASE
P
AYMENTS
.
Fixed Charge
=
(EBIT + Leases) / (Interest Charges + Leases)
=
($22.5 + $2.1) / ($6.0 + $2.1)
=
3.0 times
This ratio is used more often than the TIE ratio, especially in
industries where leasing of assets is common. It tells how many times
all fixed payments incurred by the company can be made by using all
the earnings of the firm.