Cash Flow To Debt Ratio

The cash flow to debt ratio is a coverage ratio which compares the cash flow generated by a company to its total debt. Simply stated, using its cash flow alone this metric is also used to calculate the amount of time needed for a business to pay off its debt. Cash flow from operations is most widely used to measure the ratio, although the use of unlevered free cash flow is also a viable alternative. Instead of earnings, cash flow is actually used as cash flow is a more detailed indicator of the financial potential of a company. A type of coverage ratio is the cash flow-to-debt ratio which can be used to calculate how long it will take a corporation to repay its debt if it dedicated all of its cash flow to repaying debt.

The formula for the Cash Flow-to-Debt Ratio: The lack of amortization is an apparent and important drawback of the method that uses operating cash flow instead of EBITDA. The cash flow to debt ratio assumes that year after year, the formula used for making interest and principal payments will be the same.

Cash Flow to Debt = Total Debt / Cash Flow from Operations

(Example of Cash Flow to Debt Ratio)

Some companies or organizations may decide to use their EBITDA number in the calculation. However, this is now not recommended, seeing that EBITDA takes into account new stock purchases that may additionally take a lengthy time to be offered and generate money flow. Although devoting all of its cash flow from operations to debt repayment is impractical for a company, the cash flow-to-debt ratio offers a snapshot of a company’s overall financial health. A high ratio means that a business is better able to pay back its debt and if appropriate, is also able to take on more debt.

The cash flow to debt ratio is expressed as a percentage, but can additionally be expressed in years through dividing 1 by using the ratio. This would tell us how many years it would take the business to pay off all of its debt if it has been to devote all-cash waft generated from operations to repaying debt. Total debt calculation considers interest and predominant repayments from modern-day monetary statements. Nonetheless, firms can use several different funding schemes, such as making interest-only payments, adverse amortization, bullet payments, and all the rest. In such situations, from one year to another the organization will pay different sums of interest, which basically means that present-year figures may not necessarily reflect future figures.

Analysts occasionally also examine the ratio of cash waft to simply long-term debt. This ratio may additionally supply a more favorable photo of a company’s economic fitness if it has taken on extensive temporary debt. In addition, analysts typically do not consider the cash flow from borrowing or from expenditure in estimating the cash flow to debt ratio. It is possible that a company with a highly leveraged capital structure would have quite a lot of debt to cover. It is illogical to conclude that the firm is using its debt capital to wipe out its debt. The cash flow of funding is also omitted from the computation.

We must equate it to the ratio of other businesses in the same sector to determine what a “high or low” ratio is. For a corporation, the ratio may also be looked at historically, showing how its debt coverage capacity has changed over time. In the equation, the cash flow to debt ratio has drawbacks, including omitting amortization and lease increases. In the calculation of the cash flow to debt ratio, analysts do no longer usually use the money flow from financing or money flow from investing. If the organization or company had a higher ratio result, with its cash waft from operations greater relative to its whole debt, this would point out a financially improved business that should amplify the dollar quantity of its debt repayments if needed.


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