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An important trend seen within the framework of the modern-day business world is the fact that the different business enterprises are increasingly taking bank loans or debts for the enhancement of the scope of their business. However, the major problem arises because of the fact that many enterprises fail to repay the debts or the bank loans in a timely manner which in turn adversely affects their brand image and business prospects. The concept of Interest Coverage Ratio becomes an important one in this regard.
Interest Coverage Ratio is also called by the name of Times interest earned (TIE) and is considered to be one of the most important parameters through which the ability of an enterprise to honour or repay its debts or loans is being measured. Thus, the different bank accountants and others are increasingly taking the help of this metric for the effective analysis of the ability of the enterprises to repay the debts or the loans that they have taken.
Interest Coverage Ratio in simple terms can be seen as a parameter or a metric which is being used to assess the capability as well as the ability of a particular business enterprise to respect or for that matter repay the bank loans or debts that it had taken. More importantly, the tool of Interest Coverage Ratio becomes important when the ability of a particular enterprise to repay or honour its debts is being analysed or judged. Furthermore, for the purpose of deriving this ratio, the earnings of an enterprise before taxes or interests is being divided by the total amount of interests or capital that the concerned enterprise needs to pay for the debt.
If the result of this calculation is less than the number 1 then this signifies the fact that the concerned enterprise is not generating enough revenue to repay the debts that it had taken in a timely manner. On the other hand, if the result of the calculation is more than 1 then this indicates the fact that the enterprise is generating enough revenue to repay its debts in a timely manner as agreed.
Interest Coverage Ratio and Times interest earned (TIE) are the same things and the names of the same framework although in different contexts or scenarios different names are being used. As a matter of fact, both of these two frameworks are indicative of the fact whether or not a particular business enterprise is capable enough to repay or for that matter honour the debts or the loans that it had taken.
Interest Coverage Ratio works in a rather simplistic manner and for the purpose of calculating it the business enterprises are required to take into account the interest expenses of their enterprise and also their earnings before the actual payment of the taxes or the interests. In this regard, it needs to be said that the value of the ratio determines whether or not a particular enterprise actually has the capability or the ability to repay the loans or the debts. For example, if the value of the ratio is more than 1 then this means that the enterprise would be able to repay the debts or the loans through its revenue and if it is less than 1 then this means that the enterprise would not be able to do so.
The formula for the calculation of the Interest Coverage Ratio is fairly simple and the concerned ratio can be easily calculated through the usage of the below given equation-
Interest Coverage Ratio= EBIT/Interest Expense
Wherein EBIT represents “Earnings before interest and taxes”
For calculating the Interest Coverage Ratio, the business enterprises need to divide the amount of capital that they have to spend as interest by the amount of revenue that they generate prior to the tax or the interest deductions. More importantly, the value of the ratio determines whether or not the enterprise would be able to respect its debt or loans.
Some of the important books on Interest Coverage Ratio or Times Interest Earned are listed below-
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