CSLB Law & Business ExamBusiness FinancesMedium
A contractor is evaluating the company's financial leverage and its ability to cover interest payments. Which financial ratio would be most relevant for this analysis?
- AReturn on Equity
- BCurrent Ratio
- CTimes Interest Earned (TIE) Ratio
- DDebt-to-Equity Ratio
Show answer & explanationAnswer & explanation
Correct answer: C. Times Interest Earned (TIE) Ratio
The Times Interest Earned (TIE) ratio specifically measures a company's ability to meet its debt obligations, particularly its interest payments, using its earnings before interest and taxes (EBIT).
Why the other options are wrong
- A. Return on Equity measures profitability for shareholders, not debt coverage.
- B. The Current Ratio measures short-term liquidity, not ability to cover interest.
- D. The Debt-to-Equity Ratio measures financial leverage, but not directly the ability to cover interest payments from earnings.
Times Interest Earned (TIE) Ratio
A solvency ratio that measures a company's ability to meet its debt obligations (interest payments) based on its operating income.
- Calculated as Earnings Before Interest and Taxes (EBIT) / Interest Expense.
- A higher ratio indicates a company can more easily cover its interest payments.
- Used by lenders to assess risk.
Memory trick: Solvency: Can the company pay its long-term debts and interest?