Times Interest Earned Ratio Calculator

What this times interest earned calculator does

A company with debt has to pay interest on it whether business is good or not. Times interest earned asks a simple question about that: how many times over could this year's operating profit have paid this year's interest bill?

Give this calculator EBIT and total interest expense and it returns the multiple. A result of 4.5 means profit covered interest four and a half times over.

It is the most widely used solvency ratio there is, and lenders, rating agencies and bond covenants all lean on it. What it is really measuring is not this year at all. It is measuring how much room there is for things to go wrong, and reading it that way makes the number far more useful.

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How to use it

1. EBIT. Earnings before interest and taxes, also called operating profit. Take it from the income statement above the interest line, and use the same period as the interest figure.
2. Total interest. Interest expense for the period. Use gross interest paid rather than netting off any interest received, since it is the obligation you are testing.

Press Calculate. Press Reset to clear it.

Both fields want positive numbers. A company with no debt has no interest to cover and the ratio does not apply to it, which is the sort of problem worth having. A company with negative EBIT cannot be measured here either, and that is the case where coverage matters most, so if you are looking at a loss making year the honest answer is that coverage is below zero and the interest is being paid from cash reserves or new borrowing rather than from trading. That is on our list to handle properly.

The formula

Times interest earned = EBIT ÷ interest expense

The reason EBIT is the right numerator is worth a sentence. Interest is paid out of profit before tax, because interest is itself tax deductible. So testing coverage against post-tax profit would understate the company's capacity. EBIT is the pool the interest actually comes out of.

The ratio is also called interest coverage, and the two names are interchangeable. You will meet variants that use EBITDA instead of EBIT, which produces a higher number because depreciation is added back, and there is a reason people do that.

A result below 1 means operating profit did not cover the interest bill at all. The money came from somewhere else: cash reserves, asset sales, or fresh borrowing. None of those are repeatable indefinitely.

A worked example

A company with EBIT of 180,000 and interest expense of 40,000.

180,000 ÷ 40,000 = 4.50

Operating profit covered the interest bill four and a half times.

The same company at different debt levels:

Conventional guidance puts a comfortable figure somewhere above 3, and treats anything under 1.5 as a warning. Those thresholds are rules of thumb rather than rules, and they vary by industry: a regulated utility with predictable revenue can carry a lower ratio safely than a cyclical manufacturer, because its profit does not swing.

The better way to read it: how far profit can fall

A coverage ratio of 4.5 is an abstract number. Turn it around and it becomes something you can actually feel.

Headroom = (1 − 1 ÷ coverage) × 100

That gives you the percentage by which EBIT could fall before coverage reaches 1.0, meaning before operating profit stops covering interest entirely.

Now the difference between 4.5 and 1.2 is obvious. The first company could lose more than three quarters of its operating profit and still service its debt. The second loses a sixth of it and is in trouble.

This is what the ratio is genuinely for. It is not a measure of whether a company can pay its interest this year, since you can see that from the accounts. It is a measure of how much bad news it can absorb before it cannot, and that is the question a lender is really asking.

So the sensible test is to hold your own headroom figure against how much your profits actually move. A business whose EBIT routinely swings 40 percent between good and bad years needs considerably more coverage than one whose profit barely moves, and comparing the two on the raw ratio alone misses the entire point.

What happens when interest rates move

Coverage has two moving parts and people watch only one of them. Profit falling reduces coverage, which is obvious. Interest rising reduces it just as effectively, and it can happen without the business doing anything at all.

Take a company with 180,000 of EBIT and 1,000,000 of floating rate debt:

Same business, same profit, same debt. Coverage falls from comfortable to precarious purely because the price of money changed.

Which is why the composition of the debt matters as much as the amount. Fixed rate borrowing locks the interest line and makes coverage a function of trading alone. Floating rate borrowing means your solvency ratio moves with central bank policy.

Two things worth checking on any business carrying debt. What proportion is floating rather than fixed, and when the fixed rate borrowing matures, because a loan taken out cheaply and refinanced in a higher rate environment produces exactly the move in that table on the day it rolls over.

Your coverage ratio implies a credit rating

This is the part that turns the ratio from a diagnostic into something with a price attached.

Rating agencies use interest coverage heavily when assigning credit ratings, to the point where the relationship can be run backwards. Damodaran at NYU Stern maintains a widely used table mapping interest coverage ratios to a synthetic rating, built by taking all rated companies in the United States and sorting them by coverage. Feed in your ratio and it gives you the rating a company with that coverage typically carries.

The rating then implies a default spread, which is the premium over the risk free rate that a borrower at that rating pays. Add the two together and you have an estimated cost of debt.

So the chain runs: coverage ratio, to implied rating, to default spread, to what you should expect to pay to borrow. That is genuinely useful for a private company with no rating of its own, and it is the standard method for estimating a cost of debt when there is no traded bond to observe. It feeds directly into our WACC calculator.

Two refinements in the published tables worth knowing. Smaller companies are held to a higher coverage standard for the same rating than large ones, on the reasonable grounds that a small firm's profits are less stable. And the tables are built on US data, so applying them in a market with structurally different interest rates needs adjustment.

The practical use for most people is simpler than all that. If your coverage is drifting toward the level associated with a lower rating, your borrowing costs are going to rise before anyone tells you, and the time to act is while the ratio is falling rather than after.

EBIT is not cash, and interest is paid in cash

The most important qualification on this ratio, and the reason several alternatives to it exist.

EBIT is an accounting figure. It includes revenue that has been invoiced but not collected, and it is reduced by depreciation, which is a real economic cost but not a payment made this year. Interest, by contrast, leaves the bank account.

So a company can show comfortable coverage on EBIT while struggling to find the actual money, if its customers are slow to pay or if it is spending heavily on new equipment.

Three common alternatives address different parts of that.

EBITDA coverage adds depreciation and amortisation back, on the grounds that they are not cash costs. It gives a higher and more flattering number, and it is what a lot of loan covenants use. The objection is that depreciation is a proxy for the capital spending a business genuinely has to keep doing, so ignoring it entirely overstates capacity over any long period.

Cash coverage uses cash flow from operations instead of EBIT, which sidesteps the accounting question altogether and is the most honest version if you have the cash flow statement to hand.

Fixed charge coverage widens the denominator to include lease payments and other contractual obligations, not just interest, which matters a great deal for a business that leases most of what it uses.

And one thing none of them capture: interest coverage tests the interest, not the principal. A company comfortably covering its interest can still fail when a large loan matures and cannot be refinanced. Coverage says nothing about the maturity profile, and the maturity profile is where a surprising number of failures actually originate.

Questions people ask

How do I calculate times interest earned?

Divide EBIT by interest expense for the same period. EBIT of 180,000 against interest of 40,000 gives 4.5.

What is a good interest coverage ratio?

Above 3 is generally considered comfortable and below 1.5 is a warning, though a stable utility can safely carry less than a cyclical manufacturer. Judge it against how much your own profits swing.

What does a ratio below 1 mean?

Operating profit did not cover the interest bill. The shortfall came from cash reserves, asset sales or new borrowing, none of which can continue indefinitely.

Why EBIT rather than net profit?

Because interest is paid out of profit before tax and is itself tax deductible. Using post-tax profit would understate the company's actual capacity to pay.

Should I use EBITDA instead?

It gives a higher number by adding back depreciation, and many loan covenants use it. Just know that depreciation stands in for capital spending you will eventually have to make, so the EBITDA version flatters over long periods.

What is the most useful way to read the number?

As headroom. One minus one over the coverage tells you how far EBIT can fall before it stops covering interest. A ratio of 2.0 means fifty percent, a ratio of 1.2 means about seventeen.

My company has no debt. What is my ratio?

Undefined, and that is fine. With no interest to cover the ratio has nothing to measure.

References

A note on sourcing. Interest coverage is a definitional ratio. The mapping from coverage ratios to synthetic credit ratings and default spreads described above is compiled by Aswath Damodaran at NYU Stern from the population of rated United States companies, and is the standard method for estimating a cost of debt for a company with no traded bonds. It is built on US data and separate tables apply to smaller and larger companies.

1. Damodaran, A., Ratings, Interest Coverage Ratios and Default Spread, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ratings.html
2. Damodaran, A., Estimating a Synthetic Rating and Cost of Debt, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/valquestions/syntrating.htm
3. Damodaran, A., Cost of Capital Central, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/wacccentral.html
4. Damodaran, A., Useful Data Sets, NYU Stern School of Business. https://pages.stern.nyu.edu/~adamodar/New_Home_Page/data.html