The times interest earned ratio indicates how easily a firm pays interest expenses incurred on its debt. In QuickBooks, to calculate the times interest earned ratio, you need an income statement that shows both operating income and interest expense.

 Sales revenue \$150,000 Less: Cost of goods sold 30,000 Gross margin \$120,000 Rent 5,000 Wages 50,000 Supplies 5,000 Total operating expenses 60,000 Operating income 60,000 Interest expense (10,000) Net income \$50,000

The following formula is used for calculating the times interest earned ratio:

operating income/interest expense

If you look at the income statement shown, you see that operating income, which is the income that a firm has before paying its interest expense, equals \$60,000. Interest expense shows up as \$10,000. Therefore, you calculate the times interest earned ratio by using this formula:

\$60,000/\$10,000

This formula returns the times interest earned ratio of 6. Therefore, the firm’s operating profits pay the interest expense six times over.

No standard guideline exists for the times interest earned ratio. Obviously, however, the times interest earned ratio should indicate that a firm can easily pay its interest expense. It would be sort of scary, if you think about it, for the operating income to be only a little bit greater than the firm’s interest expense. Such a situation would indicate that a modest drop in operating income would make paying interest expense impossible.