Cash Flow Coverage Ratio

Cash Flow Coverage Ratio measures the ability of the company's operating cash flow to meet its obligations, including its liabilities or ongoing concern costs.

It is an important indicator of the liquidity position of a company. The Cash Flow Coverage Ratio is often used by the banks to decide whether to make or refinance any loan.

Calculation of Cash Flow Coverage Ratio

There are different formulas used for the calculation of this ratio. Some of the most commonly used formulas are given below.

Cash Flow Coverage Ratio = Operating Cash Flows / Total Debt

Another formula used for the calculation of Cash Flow Coverage Ratio is

Cash Flow Coverage Ratio = (Net Earnings + Depreciation + Amortization) / Total Debt

This ratio also has some variations. For example, free cash flows can be used instead of operating cash flows.


Interpretation of Cash Flow Coverage Ratio

The Cash Flow Coverage Ratio tells the number of times the financial obligations of a company are covered by its earnings. The larger the operating cash flow coverage for these items, the greater the company's ability to meet its obligations.

A good Cash Flow Coverage Ratio also indicates that the company has cash flow to expand its business, withstand hard times, and not be burdened by debt servicing and the restrictions typically included in credit agreements.

A ratio of less than one indicates that there is not enough cash flow to cover loan payments and that bankruptcy is likely within two years if it fails to improve its financial position.

More Information  The Power of Cash Flow Ratios