Define TIE and ICR and provide their typical formulas used in CLFP practice.

• A. TIE = Net income / Interest expense; ICR = Net operating income / Interest expense
• B. TIE = EBIT / Interest expense; ICR = EBITDA / Interest expense
• C. TIE = EBIT / Interest expense; ICR = EBITDA or operating income / Interest expense
• D. TIE = Cash flow / Interest expense; ICR = Net income / Interest expense

Answer: (C)

You're looking at ratios that show how well a borrower can cover interest payments from earnings. Times Interest Earned (TIE) is a measure of how many times a company’s operating earnings can cover its interest expense. The standard formula is EBIT divided by Interest expense. EBIT represents earnings before financing costs and taxes, i.e., the income from core operations before debt service, so it directly reflects the money available to pay interest.

The Interest Coverage Ratio (ICR) gauges the cushion above interest payments. In CLFP practice, it’s commonly calculated as either EBITDA or operating income divided by Interest expense. Using EBITDA emphasizes cash-like earning power by adding back depreciation and amortization, while using operating income (EBIT) ties the ratio to profitability from ongoing operations. Both formulations are widely used, with the choice depending on data availability and lender preference.

Defining TIE with net income would mix in financing results and taxes, which aren’t the immediate funds available to cover debt service. Using cash flow alone for TIE would blur the distinction between operating performance and financing structure. For ICR, sticking to just one version (EBITDA only) would overlook scenarios where operating income provides a more relevant view, hence the flexible usage of either EBITDA or operating income.