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Interest earned over time is a ratio that measures a company’s ability to pay interest on loans. It is calculated by dividing earnings before interest and taxes by the amount of interest owed. A low ratio could indicate financial weakness, but there is no absolute reference number for an acceptable ratio.
Interest earned over time is a way of measuring a company’s ability to pay the interest earned on its loans. It is expressed as a ratio that is calculated by taking the company’s earnings before interest and taxes and dividing it by the amount of interest owed. Also known as the interest coverage ratio, multiplied by interest earned, or EIR, it provides a method for investors to measure the financial stability of a company. An extremely low ratio means that a business may not be able to take care of its short-term interest payments while it still has capital in reserve for day-to-day operations or emergency expenses.
Interest payments are a reality for most businesses, as borrowing money is often necessary at various stages of a business’s development. The inability to pay the interest incurred on any loan is a sign of weakness and could be a harbinger of eventual insolvency for a business. Interest on Time Earned is a ratio designed to show how many times a business can pay its interest, which can be a good indicator of its short-term financial strength.
To calculate the times interest earned for a particular company, earnings before interest and taxes, or EBIT, must be totaled. That number is then divided by the company’s total interest payable on all debts. The two numbers to be divided must come from the same predetermined time period for the calculation to be exact.
For example, a business accumulates earnings over a specified period of time of $5,000 United States Dollars (USD), a total that represents the amount they have earned before taxes and interest are deducted. During the same period, the interest owed by that company is $2,000 USD. Dividing the $5,000 USD by $2,000 USD results in an interest rate earned times 2.5. This essentially means that the company can pay its interest obligations 2.5 times before running out of principal.
While a low ratio could be problematic if it falls close to the base level of 1.0, there is no absolute reference number for an acceptable TAR. Companies in more volatile industries may require a high ratio to deal with potential ups and downs, while companies in more stable industries may get away with a lower score. It’s also not necessarily a good thing if a company has an unreasonably high interest rate for times won. This may mean that the company has spent too much capital to pay down its debt instead of making other, more valuable investments to grow the company.
Smart Asset.
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