Question

Times-Interest-Earned Ration

Calculated the times-interest-earned ratio for Smith & Sons Inc for 2015 and 2016 and comment on the company’s ability to pay its current interest payments. Did the company’s ability to pay its current interest changes improve?
Time interest earned ration = Income before interest expense and income taxes/Interest expense
Smith & Sons, Inc
Balance Sheet
Decemober 31, 2016 and 2015
(In millions)		2016	2015
Net sales		10,000	9,500
Cost of goods sold		(5,500)	(5,200)
Gross profit		4,500	4,300
Selling and administrative expenses		(2,800)	(2,700)
Income from operations		1,700	1,600
Interest expense		(300)	(250)
Income before income taxes		1,400	1,350
Income tax expenses		(420)	(400)
Net Income		980	950

Answer 1

Calulation of Income Before Interest and Income Taxes

(In millions)	2016	2015
Income Before Income Taxes	1400	1350
Add - Interest Expense	300	250
Income Before Interest and Income Taxes	1700	1600

Times Interest Earned Ratio=

Income before interest expense and income taxes / interest expense

	2016	2015
Times Interest Earned Ratio=	1700/300	1600/250
=	5.67	6.40

Times interest ratio has decreased for Smith and Sons Inc in 2016 from 2015. Times interest earned ratio is an indicator of the company’s ability to pay off its interest expense with available earnings. It is a measure of a company’s solvency, i.e. its long-term financial strength. It calculates how many times a company’s operating income (earnings before interest and taxes) can settle the company’s interest expense. A higher times interest earned ratio indicates that the company’s interest expense is low relative to its earnings before interest and taxes (EBIT) which indicates better long-term financial strength, and vice versa.

Smith and Sons Inc times interest ratio for 2016 is 5.67 times which signifies that company's ability is good to meet its interest expense, however it has been reduced in2016 with comparision to 2015 which is mainly due to increase in interest expense in 2016 by 50 millions.