Financial ratios can be very helpful in measuring the performance and health of a corporation. Each year in the investing class we take a look at Times Interest Earned. As the name implies, it reveals how many times over a corporation is able to pay the interest on its long term debt. The point is that when a corporation’s profits are no longer sufficient to pay the interest, there’s likely trouble ahead, including the possibility of bankruptcy. We usually look at and discuss the ratios for at five corporations.
Another useful analysis is to see what is happening to the Times Interest Earned ratio for a single corporation over the course of several years. Here, we show the last four years of a portion of Caterpillar’s Income Statements. In order to remove the effect of expenses the company considers unusual, we will add Unusual Expense back to EBIT after Unusual Expense to arrive at EBIT. EBIT stands for Earnings Before Interest & Taxes, and represents the profit the company generated that is available to pay interest on its long-term debt. To compute the ratio, we will divide that sum by the Interest Expense line item. A ratio of 10, for example, means that a corporation can pay the interest on its long-term debt 10 times over.
Caterpillar’s EBIT for the last four years calculates to:
2013: (.230b + 5.66b) / .465b = 12.67
2014: (.622b + 5.18b) / .479b = 11.95
2015: (1.04b + 3.17b) / .501b = 8.40
2016: (1.63b + .49b) / .499b = 4.25
As we can see, the numbers are going in the wrong direction, and quickly. This brings to mind an article that ran in BusinessWeek in February of 2009 titled, Exxon is Weaker Than You Think. The same can be said for Caterpillar.