Times Interest Earned Ratio in QuickBooks 2012

Several leverage ratios can be used in QuickBooks 2012. The times interest earned ratio indicates how easily a firm pays interest expenses incurred on its debt. To calculate the times interest earned ratio, you need an income statement that shows both operating income and interest expense.

A Simple Income Statement

Sales revenue	$150,000
Less: Cost of goods sold	30,000
Gross margin	$120,000
Rent	5,000
Wages	50,000
Supplies	5,000
Total operating expenses	60,000
Operating income	60,000
Interest expense	(10,000)
Net income	$50,000

The following formula is used for calculating the times interest earned ratio:

operating income/interest expense

If you look at the income statement shown, you see that operating income, which is the income that a firm has before paying its interest expense, equals $60,000. Interest expense shows up as $10,000. Therefore, you calculate the times interest earned ratio by using this formula:

$60,000/$10,000

This formula returns the times interest earned ratio of 6. Therefore, the firm’s operating profits pay the interest expense six times over.

No standard guideline exists for the times interest earned ratio. Obviously, however, the times interest earned ratio should indicate that a firm can easily pay its interest expense. It would be sort of scary, if you think about it, for the operating income to only be a little bit greater than the firm’s interest expense.

Such a situation would indicate that a modest drop in operating income would make paying interest expense impossible.

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