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Times Interest Earned (Cash Basis)

Evaluating a company's cash-only debt repayment abiltiy

What is the Times Interest Earned Ratio (Cash Basis)?

The Times Interest Earned (Cash Basis) (TIE-CB) ratio is very similar to the Times Interest Earned Ratio. Times Interest Earned (Cash Basis) ratio measures a company’s ability to make periodic interest payments on its debt. The main difference between the two ratio is that Times Interest Earned (Cash Basis) measures utilizes adjusted operating cash flow rather than earnings before interest and taxes (EBIT). Thus, the ratio is computed on a “cash basis”, which only takes into account how much disposable cash a business has on had; cash that can be used to make debt repayments.

The TIE-CB’s main goal is to quantify the probability that a business will default on its loans. This information is useful in determining various debt parameters such as the appropriate interest rate to be charged or the amount of debt that a company can safely take on.

 

Times Interest Earned (Cash Basis) - Summary

 

A relatively high TIE-CB ratio would mean that a company has a lot of cash on hand that it can devote to repaying debts, thus lowering its probability of defaulting on loans. This would make the business a more attractive investment for debt providers. Conversely, a low TIE-CB would mean that a company has less cash on hand to devote to debt repayments, which would in turn lead to a higher probability of default.

How to calculate the Times Interest Earned Ratio (Cash Basis)

The Times Interest Earned ratio can be calculated by dividing a company’s adjusted cash flow from operations by its periodic interest expense. The formula to calculate the ratio is:

 

Times Interest Earned (Cash Basis) - Formula

 

Where:

Adjusted Operating Cash Flow = Cash Flow From Operations + Taxes + Fixed Charges

Interest Expense – represents the periodic debt payments that a company is legally obligated to make to its creditors

While a high TIE-CB ratio is almost always favorable over a low ratio, an excessively high TIE-CB would mean that that company may not be making the best use of its cash. For instance, a high ratio could indicate that a company may be not be investing in new NPV positive projects, conducting research & development or paying our dividends to its stockholders. As a result of this, the company may see a decrease in profitability (and subsequently cash) in the long term.

 

Times Interest Earned (Cash Basis) Example

Ben’s Cookies wants to calculate its Times Interest Earned (cash basis) ratio in order to get a better idea of its debt repayment ability. Below are snippets from the business’ financial statements, with the required inputs highlighted by red boxes:

 

Times Interest Earned (Cash Basis) - Ex2
From CFI’s Cash Flow Statement Template

 

Times Interest Earned (Cash Basis) - Ex1
From CFI’s Income Statement Template

Using the formula provided above, we arrive at the following figures:

 

Times Interest Earned (Cash Basis) - Ex3

 

Here, we see that Ben’s TIE-CB slowly increases year over year, up to 41.11x interest in 2018. This would generally be a good indicator of financial health as it means that Ben’s has enough cash to pay the interest on its debt. If Ben were to apply for more loans, he will likely have a good chance of securing further financing, as creditors may deem that the business has a low probability of default.

To better understand the financial health of the business, TIE-CB ratio should be computed for a number of companies that operate in the same industry and compared. If some other firms operating in this industry see TIE-CB multiples that are, on average, lower than Ben’s, we can conclude that Ben’s is doing a relatively good job of managing its degree of financial leverage. In turn, creditors may be more likely to lend more money to Ben’s if the company represents a fairly safe investment within the bagel industry.

 

Additional Resources

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