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Interest Coverage Ratio vs Times Interest Earned: What's the Difference?

When it comes to financial ratios, there are a lot of different ways to look at a company's health. Two ratios that are often used when assessing a company's ability to pay its debts are the interest coverage ratio and the times interest earned ratio. Both ratios measure a company's ability to make its interest payments, but they do so in different ways. Here's a look at the difference between the two ratios:

What is the Interest Coverage Ratio?

The interest coverage ratio is a measure of a company's ability to make its interest payments. It is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expenses. A higher interest coverage ratio indicates that a company is better able to make its interest payments. For example, a company with an interest coverage ratio of 2.0 is able to make its interest payments twice over with its EBIT. In general, a company with an interest coverage ratio of less than 1.0 is considered to be in danger of defaulting on its debt payments.

What is the Times Interest Earned Ratio?

The times interest earned ratio is another measure of a company's ability to make its interest payments. It is calculated by dividing a company's EBIT by its interest expenses. A higher times interest earned ratio indicates that a company is better able to make its interest payments. For example, a company with a times interest earned ratio of 2.0 is able to make its interest payments twice over with its EBIT. In general, a company with a times interest earned ratio of less than 1.0 is considered to be in danger of defaulting on its debt payments.

So, What's the Difference?

The main difference between the interest coverage ratio and the times interest earned ratio is the way in which they are calculated. The interest coverage ratio is calculated by dividing a company's EBIT by its interest expenses. The times interest earned ratio is calculated by dividing a company's EBIT by its interest expenses. As you can see, the two ratios are calculated in different ways. However, they both measure a company's ability to make its interest payments. In general, a company with a higher interest coverage ratio or a higher times interest earned ratio is considered to be in better financial health.

Why Use Both Ratios?

While both ratios measure a company's ability to make its interest payments, they do so in different ways. The interest coverage ratio looks at a company's ability to make its interest payments in relation to its EBIT. The times interest earned ratio looks at a company's ability to make its interest payments in relation to its interest expenses. As a result, the two ratios provide different insights into a company's financial health. For this reason, it is generally advisable to use both ratios when assessing a company's ability to pay its debts.

The Bottom Line

The interest coverage ratio and the times interest earned ratio are two financial ratios that are often used to assess a company's ability to pay its debts. Both ratios measure a company's ability to make its interest payments, but they do so in different ways. The interest coverage ratio is calculated by dividing a company's EBIT by its interest expenses. The times interest earned ratio is calculated by dividing a company's EBIT by its interest expenses. In general, a company with a higher interest coverage ratio or a higher times interest earned ratio is considered to be in better financial health.

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