Times interest earned ratio tells us about an organization’s ability to meets its interest obligations. In other words, it tells us how many times pre-tax income covers the interest obligations and as a result, the higher the ratio is, the better because it implies better liquidity position (Investopedia).

The data for both Pepsi and Coca-Cola came from their respective 10-K statements for the fiscal year 2013 (Pepsi Co.) (Coca-Cola Co.). As far as Coca-Cola is concerned, the company’s times interest earned ratio improved from 27.47 in the fiscal year 2011 to 29.74 in the fiscal year 2012 but declined to 24.78 the following year in 2013. In contrast, Pepsi’s times interest earned ratio declined from 10.32 in the fiscal year 2011 to 9.23 in the fiscal year 2012 but improved to 9.75 in the fiscal year 2013.

As we analyze Coca-Cola’s times interest earned ratio during the period, we note that the company’s pre-tax income improved from approximately $11.46 billion in 2011 to approximately $11.81 billion in 2012 but slightly declined in 2013 to approximately $11.48 billion. Even if the company’s interest expense had remained same in each of the year, its times interest earned ratio would have improved in 2012 as compared to 2011 level but deteriorate in 2013 as compared to 2012. But as we note in the income statement, 2012 was not only a better year in terms of pre-tax income but also interest expense. Interest expense declined from $417 million in 2011 to $397 million in 2012 before again reversing the course in 2013 when it jumped to $463 million. Thus, even if the pre-tax income would have been same in all three years, we would still have seen the times interest earned ratio to decline in 2012 as compared to 2011 and rising again in 2013 as compared to 2012.

As far as Pepsi’s times interest earned ratio is concerned, we note that the company’s pre-tax income declined from approximately $8.83 billion in 2011 to approximately $8.3 billion in 2012 but slightly improved in 2013 to rise to approximately $8.9 billion. Even if the company’s interest expense had remained same in each of the year, its times interest earned ratio would have declined in 2012 as compared to 2011 level but improve in 2013 as compared to 2012. But as we note in the income statement, 2012 didn’t only see a decline in pre-tax income but also a jump in interest expense. Interest expense increased from $856 million in 2011 to $899 million in 2012 before rising again in 2013 to $911 million. Even though the interest expense increased in 2013 as well, the proportional rise in pre-tax income was higher which enabled the company to improve its times interest earned ratio.

If we compare Coca-Cola to Pepsi, it is reasonable to assume the fact that Pepsi has significantly higher financial leverage than Coca-Cola as evident by the fact that the company’s interest expense was higher than Coca-Cola in each of the three years even though Coca-Cola earned higher pre-tax income in each of the three years. We also note that both companies had higher interest expense in 2013 as compared to 2012. It may be that both companies have taken on higher debt to fund capital investment projects as U.S. economy and global economy may be showing signs of improvement. Bu8t one thing is clear that Coca-Cola has significantly better liquidity status than Pepsi and Pepsi’s management should take measures to reduce financial leverage. Doing so will not only improve Pepsi’s liquidity position but also its profitability.