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Times Interest Earned Ratio | Formula | Calculation with Examples - YouTube
Channel: WallStreetMojo
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hello everyone hi welcome to the channel
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clicking the bell icon today we have a
topic with us is called time interest on
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ratio now let's talk about this in a
detail format you know over here we have
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an example or a graph of Volvo AB Times and their interest that is the turn ratio is
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closely 15.83 I'm now going to take you
directly you know what does this mean or
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how much times what exactly is the
interpretation no first let's understand
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a step by step what this ratio is all
about we'll get back to this and then
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we'll analyze that you know what Volvo's
times interest earned is increasing
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every year and what does this 15.83 shows us so let's begin on that so first what
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is the times interest earned ratio what is
this well C times interest on ratio is
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basically again a solvency ratio which
measures the ability of the organization
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to pay its debt obligation also it is
known as we can see that it is interest
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coverage ratio the lenders commonly use
it to a certain if the borrower can take
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on the additional own the times interest
ratio is calculated by dividing the
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earnings of the company before it pays
interest by the interest expense or the
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ratio is division by simply earning
before interest and tax to interest
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expense so we wrote from the chart that
saw over here of Volvo if we just try
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and see look at the analysis we note
that from the about chart of Volvo's
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times interest has been steadily
increasing over the time and this is
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very good situation to be in due to the
company's increasing capacity to pay
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interest you can see from 2014 to 2017
and then it goes on and on the graph of
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is just going up so it's really good so
analysts should consider but
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time series of the ratios a single point
ratio may not be very good measure or it
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may include one time revenue or earnings
but companies with consistent if you see
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consistent the ratio over a period of
time does indicating you know it's a
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better position to service the tip
however you know the smaller company and
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startups which do not have consistent
earning will have
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variable duration they will have a
variable ratio over times with us
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lenders do not prefer to give loans or
to such companies and you know this
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companies offer higher equity and they
raise money from the private equity
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venture capital that's we see let's
understand this formula now let's get to
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the next step that is the formula the
times interest earned formula is equal
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to EBIT/ interest expense this is the
formula so clearly the ratio gives how
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many times you know the interest can
cover the interest expense - its pre-tax
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in pre interest earnings the banks and
the financial lenders often look at
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various financial ratios - to mind the
solvency of the company and whether it
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will be able to service its debt before
taking on more debt so the bank's look
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at the debt ratio the D to E Debt to
equity ratio and the times interest
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earned ratio often you know that ratio
and debt to equity ratio if you see for
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this one is a measure of the capital
structure of the company and it
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indicates the exposure of the company to
debt financing relative to the assets
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were equity respectively but however I
know the times interest over here this
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ratio measures if the company is earning
enough to pay off its interest now high
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times interest earned ratio is favorable
it is good it's not bad it is good
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as it indicates the company is earning
higher than it is and will be able to
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service its obligation whereas you know
if see for the lower values it indicates
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the company may not be able to fulfill
the obligations but that may be the case
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now you need to know that you know many analysts use EBITDA in the numerator
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instead of the EBIT which I think you
know absolutely fine if you use it
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consistently over the years that's
that's good there's no problem in that
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it's a good measure it's a good driver
does you know the new ratio becomes you
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know the time interest on ratio if you
just want to change over here instead of
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EBIT now this is the extra knowledge
you know I am sharing with you that in
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or fifth instead of over here if the
companies are like airline companies
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they have huge rental then you need to
add over here R that is a rentals EBITDA
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times interest coverage you know
sometimes they take EBITDA are also or a
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EBITDA if they are paying fees so it
depends upon company to company you
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which industry in which they are
operating so this is done because you
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know depreciation amortization expense
are here they count you know not actual
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cash outflows it doesn't go out from
your pocket so for the given period
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so does removing such what we can see
here if you remove such ena over here
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you know it reflects better earning or
past you the company to pay interest
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expense arguably the depreciation and
amortisation
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spends in directly relates to the what
we call as the future business it needs
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to buy fixed and intangible assets and
thus you know the funds may not be
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available for the payment of the
interest expense
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this was the formula now let see the
calculations on the seam let's take an
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example here suppose that let's say you
know you have two companies one is alpha
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and another one is beta in a similar
industry so the two companies have you
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know some data over here as below like
you know alpha data and beta well
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the data of a bet is given 15 million
and 10 million interest expense
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5 million 7 million
so in this scenario the company's alpha
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is going to EBIT divided by interest
expense and control are so 1.42
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so in the above example we can see
no the company alpha has higher times
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interest on ratio than the company beta
and those relatively company alpha is
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better financial position than company
beta and the lender will be more willing
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to give additional debt to alpha then
company to beta so the times through
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interest ratio of the company beta is
greater than one which indicates that it
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generates sufficient earning to cover
more interest payments does you know the
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lenders may look at the other factors
they may look at the other factors like
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you know debt ratio that to equity
industry standards to decide so
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companies with the times interest ratio of
if you say less than one are unable to
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service their debt so they cannot meet
their interest requirements from their
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owning and they must dig into their
reserves to pay off the obligations now
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I'll take you to the Advantage part now
what is the advantage of this of this
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ratio see it is very easy to calculate
the times interested is indicated or
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indication of solvency of the company
the ratio can be used as an absolute
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measure of the financial position you
know the ratio can be used as a relative
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measure to company two or more companies
and the negative ratio indicates in the
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company's are serious financial troubles
now if you see for the disadvantage over
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here although a good measure of solvency
the ratio has its disadvantage you know
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we'll have a look at the floors and that
you know the bad drops of calculating
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this ratio the first thing is that you
know the earning before interest tax
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used in the numerator in accounting
figure which may not be representative a
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EBIT we are talking about enough cash
generated by the company so the ratio
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could be can be higher it can be lower
it does not indicate the company has
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actual cash to pay the interest expense
that's a flaw the amount of the interest
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expense used in denominator of the ratio
is again an accounting measurements
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discount they have interest expense to
be paid so towards such issues it is
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advisable to use the interest rate on
the face of the bonds the ratio only
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considers the interest expense it does
not account for the principle payment so
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the principle payment may be huge it
leads to the company to insolvency but
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further the company may be bankrupt or
may have to refinance what we call as at
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the higher interest rates and
unfavorable terms so those while
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analyzing the solvency of the company
are the ratios like debt and equity debt
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ratio should also be considered
let me give my final thoughts on this C
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times interest alone ratio measures the
company solvency and its ability to
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service its debt obligation so this
ratio is indicative of the number of
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times the earnings to the interest
expense of the company so higher the
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ratio is better is the financial
position of the company and it is better
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candidate to raise more more funds and
moded so a ratio of greater than 1 this
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favorable however lenders should not
rely on the ratio unknown to decide
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other factors and ratios like debt ratio
that equity industry and economic
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condition should also be considered
before lending so that's it for this
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particular topic if you have learned and
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