Long-Term Financing: Bonds

A company can purchase bonds as an investment or can issue bonds as a mechanism to raise capital. It is important to understand the different types of bond issues that a company can use, and the impact of interest rates on those bonds. After this reading, you will be able to explain how a company can use long-term bonds as part of their capital budget.

Analyzing and using the financial results—Times interest earned ratio

The times interest earned ratio (or interest coverage ratio) indicates the ability of a company to meet required interest payments when due. We calculate the ratio as follows:

$Time\ interest\ earned\ ratio\ = \frac{Income\ before\ interest\ also\ taxes(IBIT)}{ Interest\ expense}$

Income before interest and taxes (IBIT), also called "earnings before interest and taxes (EBIT)", is the numerator because there would be no income taxes if interest expense is equal to or greater than IBIT. To find IBIT when the income statement is not complex, take net income and add back interest expense and taxes. However, in complex situations, when there are discontinued operations, changes in accounting principle, extraordinary items, interest revenue, and/or other similar items, analysts often use "operating income" to represent IBIT. The higher the ratio, the more comfortable creditors feel about receiving interest payments in the future