Day 3 of Fundamental Investing
This is the 3rd and most used ratio when it comes to analysing the Liquidity of a company.
The third ratio is called the Times Interest Earned Ratio.
What is it?
The times' interest earned ratio, sometimes called the interest coverage ratio, is a coverage ratio that measures the proportionate amount of income that can be used to cover interest expenses in the future. In some respects, the times' interest ratio is considered a solvency ratio because it measures a firm’s ability to make interest and debt service payments. Since these interest payments are usually made on a long-term basis, they are often treated as an ongoing, fixed expense. As with most fixed expenses, if the company can’t make the payments, it could go bankrupt and cease to exist.
How to calculate it?
Here's an image for the same:
What's its significance?
The times' interest ratio is stated in numbers as opposed to a percentage. The ratio indicates how many times a company could pay the interest with its before-tax income, so obviously, the larger ratios are considered more favourable than smaller ratios.
In other words, a ratio of 4 means that a company makes enough income to pay for its total interest expense 4 times over. Said another way, this company’s income is 4 times higher than its interest expense for the year.
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