Many companies get loans in order to help finance their operations. Interest must be paid on these loans to the creditors. The times interest ratio (TIE), also known as the interest coverage ratio, is a metric that allows companies to measure their ability to meet their debt obligation (“Time Interest Earned – TIE,” 2018). In other words, this metric allows a company, like PepsiCo, understand how many times it can cover those interest expenses. This is measured on a pretax earnings basis. The table below compares the times interest earned ratio of PepsiCo, and its main competitor, The Coca-Cola Company. The following information used in the calculations were derived from PepsiCo’s and Coca-Cola’s 2017 annual report.
Times Interest Earned Ratio (TIE)
Income Before Income Taxes (in Millions) / Interest Expense (in Millions) = TIE times
2016 8,553M / 1,342M = 6.37 times 8,136M / 733M = 11.10 times
2017 9,602M / 1,151M = 8.34 times 6,742M / 841M = 8.02 times
The higher the TIE ratio of a company is, the more favorable it becomes. Any company above a 2.5 TIE ratio is considered to have an acceptable risk. Both of these companies have had more than double this ratio amount during 2016 and 2017. In 2016, Coca-Cola exceeded PepsiCo by 4.73. Coca-Cola’s earnings were significantly higher than its interest obligations, allowing it to reach a TIE ratio of 11.10. This decreased in the following year, because the earnings were less capable of meeting the interest obligations. Coca-Cola’s gross profit decreased from $25,398 million in 2016 to $22,154 million in 2017, at the same time, the company’s debt increased (The Coca-Cola Company, 2018, p. 72). While Coca-Cola suffered a decrease, the TIE ratio of PepsiCo increased from 6.37 to 8.34. This is most likely due to the decrease in interest expense, as well as, the increase in gross profit from $34,590 million in 2016 to $34,740 million in 2017, among other beneficial increases. PepsiCo had been on a rise, while Coca-Cola was falling.
Firms will often use debt in order to finance their assets, when they do not have enough financial resources on hand. The amount of that debt being put to use in order to finance assets may be referred to a company’s leverage. The debt ratio measures the extent of this leverage. Higher debt ratio implies greater financial risk (“Debt Ratio,” 2018). The table below compares the debt ratios of PepsiCo and Coca-Cola in both 2016 and 2017. The following information used in the calculations were derived from PepsiCo’s and Coca-Cola’s 2017 annual report.
Total Liabilities (In Millions) / Total Assets (In Millions) = Debt Ratio
2016 62,291M / 73,490M = .8476 = 84.76% 64,050M / 87,270M = .7339 = 73.39%
2017 68,823M / 79,804M = .8624 = 86.24% 68,919M / 87,896M = .7841 =
Both companies fail to experience any drastic changes in their debt ratios from 2016 to 2017, but they do each experience an increase. PepsiCo increased its debt ratio by 1.48%, while Coca-Cola experienced an increase of 5.02%. PepsiCo and Coca-Cola both have high debt ratios. This means that most of the companies’ assets are being financed by debt, as opposed to revenue. Still, since the debt ratios are below 100%, both companies have more assets than debts. From 2016 to 2017, Coca-Cola had its debt ratio increase by more than three times that of PepsiCo’s debt ratio increase. The reason for this can be explained by looking at the total liabilities and total assets of the two companies. From 2016 to 2017, PepsiCo increased its total assets by $6,314 million, and increased its total liabilities by $6,532 million (PepsiCo, 2018, p. 82). These amounts are fairly close, therefore, there was not a huge offset. Since there was slightly bigger increase in the total liabilities, the debt ratio went up slightly by 1.48%. From 2016 to 2017, Coca-Cola increased its total assets by only $626 million, and increased its total liabilities $4,869 million, more than seven times the amount of the asset increase (The Coca-Cola Company, 2018, p. 74). This is why the company experienced a 5.02% increase in its debt ratio. The number of total liabilities far exceeded the total assets. While Coca-Cola incurred a lot more liabilities than assets, PepsiCo kept its numbers fairly close.