The times interest earned ratio, or TIE, is a period’s earnings before interest and taxes divided by that same period’s interest expense, and the answer is how many times over those earnings cover the interest expense recorded for that period. It carries a second name, the interest coverage ratio. The ratio stops at interest, so it is silent on the principal repaid alongside it.
Where the Two Inputs Are Read Off
On a statement of comprehensive income filed with the Securities and Exchange Commission, interest sits at caption 8, interest and amortization of debt discount and expense (17 CFR 210.5-03), below the operating captions and above the pre-tax line, with the rest of that stretch set out in operating income vs net income.
The numerator is the input that has to be named. On a multi-step income statement the operating subtotal stops before the non-operating captions, so in any period carrying non-operating income or non-operating expenses EBIT and the operating subtotal are different figures, a distinction worked through in the equation for operating income and carried a step further in EBITDA.
A Worked Example
Say a company closes a year on the amounts below, with non-operating income in the period.
Operating income for the year 420,000
Non-operating income for the year 30,000
EBIT 450,000
Interest expense for the year 125,000
TIE 450,000 / 125,000 = 3.6
Same test on the operating subtotal
420,000 / 125,000 = 3.36One year, one set of books, two answers. Nothing in the denominator moved, so the whole gap is the non-operating income the operating subtotal leaves out. Name the numerator before quoting the ratio.
Published Definitions Disagree About the Numerator
A Federal Reserve Board staff note defines the interest coverage ratio as the ratio of earnings before interest and taxes to interest expenses, computed for a firm in a fiscal year as EBIT for that year over its interest expenses in the same year (FEDS Notes, 2019).
An American Bar Association ratio summary writes it as operating profit divided by interest expense instead (Summary of Financial Ratios, Emerging Companies Guide, Third Edition), and a federal loan rule puts EBITDA there, quoted in the fixed charge coverage ratio.
Federal rural electric loan rules define TIER, the Times Interest Earned Ratio of the borrower, from two named inputs, and neither is EBIT: interest expense on total long-term debt, and the borrower’s patronage capital or margins, each read off a specified line of a filed report rather than off the income statement (7 CFR 1710.2).
So when the ratio reaches a firm as a loan covenant, the credit agreement’s own definitions of earnings and of interest expense govern the calculation, not GAAP. How covenants are classified, and when each kind is tested, is set out in covenants.
What the Times Interest Earned Ratio Leaves Out
The denominator is interest and nothing else, so the test never asks where the scheduled principal comes from.
The debt service coverage ratio. DSCR puts the scheduled principal alongside the interest and measures a period’s cash flow against the total, which is the question this ratio skips.
The fixed charge coverage ratio. Fixed charge coverage widens the denominator in another direction, past interest into rent and lease payments.
The balance sheet tests. The times interest earned ratio is a flow test over one period rather than a balance sheet reading, which keeps it apart from solvency and the liquidity ratios.
Common Questions
Divide the period’s EBIT by the same period’s interest expense, and where a document asks for the ratio, take both inputs from that document’s definitions clause instead.
No authority sets a universal level. Federal Reserve Board staff report that the literature is less clear on what value should be considered critically low, and that critical levels depend on firm and sector conditions; across the industries they report, the median threshold written into loan covenants runs from 4.00 for security and commodity brokers down to 1.00 for nondepository institutions (FEDS Notes, 2019).
Where a rule fixes a level, it fixes it for its own borrowers. Rural electric distribution borrowers must meet a minimum TIER of 1.25, applied on an annual basis or on the average of the 2 best years out of the 3 most recent calendar years, and even that requirement is the one set out in the borrower’s mortgage or loan contract, which the Administrator may raise or lower case by case (7 CFR 1710.114).
A higher reading means more headroom on interest, and it is the direction a lender testing an interest covenant wants. It is not a verdict on the debt itself. A high ratio can simply mean the business carries very little of it.
Accountably places trained offshore accountants and tax preparers inside US CPA and EA firms, and a firm can run a real block of its own close and covenant compliance work through a trial task before any client work depends on it.
