Final answer:
The interest coverage ratio, or times interest earned (TIE), is a financial metric used to assess a company's ability to meet its interest payments. It evaluates the protection a company has from defaulting by comparing operating income to interest expense. A high ratio indicates good financial health and protection, while a low ratio may suggest financial distress.
Step-by-step explanation:
The ratio that pertains to a company's ability to meet its interest payments is known as the interest coverage ratio or times interest earned (TIE). This ratio is a financial metric that compares a company's operating income to its interest expenses. The formula for calculating the interest coverage ratio is operating income divided by interest expense. A higher ratio indicates that the company is generating enough earnings to cover its interest obligations, which in turns suggests financial stability and protection against potential default. On the other hand, a low interest coverage ratio could signal financial distress, indicating that the firm may struggle to meet its interest payments, raising the risk of default.
Understanding this ratio is crucial for investors and creditors as it provides insights into the financial health of a company. A company with a robust interest coverage ratio shows that it is less risky and has a cushion to withstand financial downturns. The ratio acts as a safeguard, ensuring that the company can continue to service its debt even if its earnings face a temporary decline. However, a variety of factors, such as market conditions and business cycles, can influence this ratio over time.