The method to determine the times interest earned metric involves dividing a company’s earnings before interest and taxes (EBIT) by its interest expense for a specific period. EBIT represents the operating profit prior to accounting for financing costs and tax obligations. The interest expense is the cost incurred by the company to service its debt. For example, if a company has an EBIT of $500,000 and interest expense of $100,000, the ratio is 5, meaning the company’s earnings can cover its interest obligations five times over.
This financial ratio provides insights into a company’s ability to meet its debt obligations. A higher ratio generally indicates a stronger capacity to comfortably pay interest expenses, which can be attractive to creditors and investors. It serves as an indicator of financial stability and reduces the perceived risk associated with lending to or investing in the company. While the specific origins are difficult to pinpoint, the use of such solvency ratios has evolved alongside the development of modern accounting practices and financial analysis, becoming a standard tool for assessing financial health.
