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Evaluating a company’s cash-only debt repayment abiltiy
Published February 10, 2023
Updated July 7, 2023What 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) measures a company’s ability to make periodic interest payments on its debt. The main difference between the two ratios is that Times Interest Earned (Cash Basis) 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 hand. This is 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 a lender should charge the company or the amount of debt that a company can safely take on.
A relatively high TIE-CB ratio indicates that a company has a lot of cash on hand that it can devote to repaying debts, thus lowering its probability of default. This makes the business a more attractive investment for debt providers. Conversely, a low TIE-CB means that a company has less cash on hand to devote to debt repayment. Thus, there would be a higher probability of default.How to calculate the Times Interest Earned Ratio (Cash Basis)
The Times Interest Earned ratio CB 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:
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 preferred over a low ratio, an excessively high TIE-CB may mean the company may not be making the best use of its cash. For instance, a high ratio could indicate that a company may not be investing in new NPV positive projects, conducting research & development, or paying out 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:
Using the formula provided above, we arrive at the following figures:
Here, we see that Ben’s TIE-CB slowly increases year over year, up to 41.11x interest in 2023. 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 likely has a good chance of securing further financing, as there is a relatively low probability of default.
To better understand the financial health of the business, the TIE-CB ratio should be computed for a number of companies that operate in the same industry. If 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 better job of managing its financial leverage. Creditors are more likely to extend further credit to Ben’s, over its competitors, if needed.Additional Resources
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