The times interest earned ratio is based on net income because that is the amount of earnings that is available for making interest payments. Interest expense is deducted before taxes are determined; creditors have first claim on the earnings before taxes are paid.

Question

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The times interest earned ratio is based on earnings before interest and taxes (EBIT), not net income, because it measures a company's ability to cover its interest expenses with its operating earnings, without the effects of taxes and interest expenses.

The Times Interest Earned Ratio Is Based on Net Income