The Times Interest Earned Ratio is an excellent profitability ratio and also one of the most common ratio that is used by lenders when making business loans. The Times Interest Earned Ratio is arrived at by dividing the operating income by the interest expenses faced the small business on all its debt obligations. Thus the times interest earned ratio measures the ability of the small business to cover its interest cost from its operations.
We are projecting that the times interest earned ratio for Lights On Electrical will be 19.8, 34.1 and 54 for 2015, 2016 and 2017 respectively. This are some excellent numbers. A small business uses its operating income which is the profit before income and taxes to make interest and tax payments. Clearly the higher the operating income the better the ability of the business owners like Andy and Jose to pay the interest on their loans. Both the owners do not believe in debt and have only opted to apply for one five year term loan. As time progresses the interest component of the loan will begin dwindling down and that is why we have an improving times interest earned ratio for the firm.
Clearly if, the business was to take on more debt resulting in higher interest payments, the times interest earned ratio would be impacted negatively. Alsoif the operating income were to be reduced due to slower sales and / or higher operating expenses, this ratio would again get worse.
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