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Calculating the times interest earned ratio

From: Excel 2007: Financial Analysis

Video: Calculating the times interest earned ratio

When a company borrows money to finance its operations, it must pay interest on those loans so the lender can make a profit on the transaction. The more money a company makes, the more comfortably it can handle those interest payments. The Times Interest Earned Ratio calculates the number of times a company could pays its yearly interest bill based on its earnings before interest and taxes. To calculate a company's Times Interest Earned Ratio, you divide Earnings Before Interest and Taxes or EBIT by the interest paid for the year. So, in this worksheet I have Earnings Before Interest and Taxes, Interest, and also Taxes.

Calculating the times interest earned ratio

When a company borrows money to finance its operations, it must pay interest on those loans so the lender can make a profit on the transaction. The more money a company makes, the more comfortably it can handle those interest payments. The Times Interest Earned Ratio calculates the number of times a company could pays its yearly interest bill based on its earnings before interest and taxes. To calculate a company's Times Interest Earned Ratio, you divide Earnings Before Interest and Taxes or EBIT by the interest paid for the year. So, in this worksheet I have Earnings Before Interest and Taxes, Interest, and also Taxes.

Even though we don't use the Taxes figure in this formula, you'll usually find it on a worksheet or in an annual report along with the Interest and the EBIT, Earnings Before Interest and Taxes. But you don't need to worry. It's not used in the formula. To calculate the Times Interest Earned Ratio, you divide the Earnings Before Interest and Taxes by the interest that's due in a given year. So, to that you divide B5, the EBIT, by Interest, and press Return, and there is your result. This company makes six times the money it needs to pay its interest every year, which indicates a healthy earning power and that it's a no danger of defaulting on any of its loans.

Now, even though it might seem prudent to keep a company's Times Interest Earned Ratio as high as possible, an extremely high ratio might indicate that a company either has not taken on enough debt to pursue new opportunities, or that it is paying down its current debt too quickly, using funds that could be invested elsewhere. By contrast, a low Times Interest Earned Ratio won't be a problem for a company with a lot of cash in the bank, but the closer the ratio gets to 1, the more likely it is that company will run into problems. Potential lenders can use the Times Interest Earned Ratio to evaluate a company's creditworthiness, and potential investors can use the number to determine whether a company is managing its debt load effectively.

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This video is part of

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Excel 2007: Financial Analysis

51 video lessons · 13631 viewers

Curt Frye
Author

 
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  1. 2m 6s
    1. Welcome
      1m 8s
    2. Using the exercise files
      32s
    3. Disclaimer
      26s
  2. 13m 20s
    1. Separating inputs and formulas
      2m 2s
    2. Avoiding common mistakes
      5m 39s
    3. Tracing formula precedents and dependents
      2m 52s
    4. Evaluating Excel formulas step by step
      2m 47s
  3. 18m 40s
    1. Tracking income and expenses using an Excel table
      3m 29s
    2. Creating a Pivot Table from table data
      3m 36s
    3. Pivoting a Pivot Table
      2m 22s
    4. Filtering a Pivot Table
      3m 11s
    5. Adding Pivot Table columns to enhance data analysis
      3m 5s
    6. Tracking cash flow using a Pivot Chart
      2m 57s
  4. 18m 48s
    1. Reading a corporate financial statement
      6m 1s
    2. Introducing common-sizing strategies for analyzing financial statements
      3m 59s
    3. Creating common-sized income statements
      3m 1s
    4. Creating common-sized balance sheets
      2m 53s
    5. Calculating percentage changes in financial statements
      2m 54s
  5. 8m 12s
    1. Calculating earnings per share
      1m 54s
    2. Calculating return on equity and return on assets
      2m 50s
    3. Calculating gross profit margin and net profit margin
      3m 28s
  6. 6m 19s
    1. Calculating the current ratio and quick ratio
      2m 47s
    2. Calculating the average collection period
      1m 56s
    3. Calculating inventory turnover
      1m 36s
  7. 6m 12s
    1. Calculating the equity ratio
      1m 26s
    2. Calculating the debt ratio
      2m 57s
    3. Calculating the times interest earned ratio
      1m 49s
  8. 10m 58s
    1. Calculating simple interest and compound interest
      3m 36s
    2. Applying nominal versus effective interest rates (APR versus APY)
      3m 21s
    3. Calculating the number of days between events
      4m 1s
  9. 13m 32s
    1. Computing the future value of an investment
      3m 30s
    2. Calculating present value
      2m 29s
    3. Calculating net present value
      2m 42s
    4. Calculating internal rate of return
      2m 24s
    5. Calculating NPV and IRR for uneven input periods (XNPV and XIRR)
      2m 27s
  10. 7m 30s
    1. Projecting future results using the Forecast function
      2m 9s
    2. Performing quick forecasts using the Fill handle
      2m 57s
    3. Adding a trendline to a chart
      2m 24s
  11. 22m 28s
    1. Introducing amortization
      2m 20s
    2. Calculating payments on a fully amortized loan
      2m 21s
    3. Calculating payments on a partially amortized loan (balloon payments)
      2m 4s
    4. Calculating interest and principal components of loan repayments
      5m 32s
    5. Introducing depreciation
      2m 1s
    6. Calculating straight line depreciation
      1m 30s
    7. Calculating declining balance depreciation
      3m 24s
    8. Calculating double declining balance depreciation
      3m 16s
  12. 9m 34s
    1. Introducing bonds and bond terminology
      1m 37s
    2. Calculating a bond's yield
      2m 15s
    3. Calculating the value of zero coupon bonds
      3m 18s
    4. Pricing bonds to be offered to investors
      2m 24s
  13. 23s
    1. Goodbye
      23s

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