Understanding Times Interest Earned

Times Interest Earned

Times Interest Earned is also known as "Interest Coverage" ratio. Look up pretax earnings, and add back interest expense- this gives earnings before interest and taxes (EBIT). Divide EBIT by interest expense, and you will know how many times the company could have paid the interest expense on its debt. The more times the company can pay its interest expense, the less likely that it will run into difficulty if earnings should fall unexpectedly.

Times Interest Earned = Profit before Interest & Taxes (PBIT)/Interest Expense

Calculating Times Interest Earned

Times Interest Earned is simply calculated by adding Profit Before Tax (PBT) and Interest charges and  dividing the result by Interest charges. Both Profit before Tax and Interest charges can be taken from the Profit and Loss Statement from the firm's Annual Reports. Annual Reports can usually be found at the firm's website or from SEBI EDIFAR database. Interest charges includes interest cost for the debt carried by a company and other charges such as financial transaction fees.

Rough benchmarks for analysing a firm's Interest Coverage

It is tough to say how low this metric can go before you should be concerned -but higher is definitely better. You want to see higher Interest coverage for a company with a more volatile business than for a firm in a more stable industry. Be sure to look at the trend in Interest coverage over time as well. Calculate the ratio for the past 5 years, and you will be able to see the company is becoming riskier -Interest coverage is falling - or, whether its financial health is improving. 

You may also like to learn more on other financial strength measures, as below.