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Introduction: Understanding the Cash Debt Coverage Ratio
The cash debt coverage ratio is a measure of a company’s ability to pay off its long-term liabilities using its cash and cash equivalents. It is an important financial ratio that helps investors and creditors determine the financial health of a company and its ability to meet its obligations.
What is the Cash Debt Coverage Ratio?
The cash debt coverage ratio is a financial ratio that measures the ability of a company to repay its long-term debt obligations using its cash generated from operations. It is calculated by dividing the company’s cash flow from operating activities by the total amount of long-term debt that is due within the current year.
Formula for Cash Debt Coverage Ratio
The formula for the cash debt coverage ratio is:
Cash Debt Coverage Ratio = Cash from Operating Activities / Current Portion of Long-Term Debt
Where:
Cash from Operating Activities = Net cash inflow/outflow from operating activities (from the Statement of Cash Flows).
Current Portion of Long-Term Debt = The amount of the long-term debt to be paid off within the current year.
For example, if a company has cash from operating activities of $500,000 and a current portion of long-term debt of $100,000, the cash debt coverage ratio would be:
Cash Debt Coverage Ratio = $500,000 / $100,000 = 5.0
This means that the company is able to cover its current long-term debt obligations 5 times using its cash generated from operating activities.
Why is the Cash Debt Coverage Ratio Important?
The cash debt coverage ratio is an important financial ratio as it helps investors and creditors determine the financial health of a company and its ability to meet its long-term debt obligations. A high cash debt coverage ratio indicates that a company is generating enough cash from its operations to cover its current long-term debt obligations.
On the other hand, a low cash debt coverage ratio may indicate that a company is not generating enough cash from its operations to meet its long-term debt obligations, which may be a concern for investors and creditors.
Cash Debt Coverage Ratio Example
Let’s take an example to see how the cash debt coverage ratio is calculated. ABC Inc. has the following information:
Cash from operating activities = $300,000
Current Portion of Long-Term Debt = $50,000
Using the formula, the cash debt coverage ratio would be:
Cash Debt Coverage Ratio = $300,000 / $50,000 = 6.0
This means that ABC Inc. is able to pay off its current long-term debt obligations 6 times using its cash generated from operating activities.
Cash Debt Coverage Ratio Interpretation
The cash debt coverage ratio interpretation depends on the industry the company operates in. Typically, a ratio of 1 or higher is considered acceptable, as it indicates that the company is generating enough cash from operations to cover its current long-term debt obligations.
However, some industries may require a higher cash debt coverage ratio to be considered financially healthy. For example, companies in the oil and gas industry may require a higher ratio due to the high capital-intensive nature of their operations.
Similarly, companies with a high level of debt may require a higher cash debt coverage ratio as they have a higher risk of defaulting on their debt obligations.
Cash Debt Coverage Ratio vs. Debt Coverage Ratio
The debt coverage ratio is another financial ratio that is used to determine a company’s ability to meet its debt obligations. The debt coverage ratio takes into account all of a company’s debt obligations, both long-term and short-term.
The formula for the debt coverage ratio is:
Debt Coverage Ratio = Cash from Operating Activities / Total Debt
Where:
Cash from Operating Activities = Net cash inflow/outflow from operating activities (from the Statement of Cash Flows).
Total Debt = The total amount of all debt obligations, both long-term and short-term.
The debt coverage ratio provides a more comprehensive analysis of a company’s ability to meet its debt obligations, but it does not provide a breakdown of the company’s ability to meet its long-term debt obligations separately.
FAQs:
1. What is a good cash debt coverage ratio?
A cash debt coverage ratio of 1 or higher is generally considered good.
2. What does a low cash debt coverage ratio indicate?
A low cash debt coverage ratio may indicate that a company is not generating enough cash from its operations to meet its long-term debt obligations, which may be a concern for investors and creditors.
3. What industries require a higher cash debt coverage ratio?
Industries with high capital-intensive nature, such as oil and gas, may require a higher cash debt coverage ratio. Similarly, companies with high levels of debt may require a higher ratio as they have a higher risk of defaulting on their debt obligations.
4. What is the difference between cash debt coverage ratio and debt coverage ratio?
The cash debt coverage ratio measures a company’s ability to pay off its long-term debt obligations using its cash generated from operations. The debt coverage ratio, on the other hand, takes into account all of a company’s debt obligations, both long-term and short-term.
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Article Summary:
The cash debt coverage ratio measures a company’s ability to pay off its long-term liabilities using its cash and cash equivalents. It is calculated by dividing the company’s cash flow from operating activities by the total amount of long-term debt that is due within the current year. A ratio of 1 or higher is generally considered acceptable, but some industries may require a higher ratio. The ratio helps investors and creditors determine the financial health of a company and its ability to meet long-term debt obligations. The debt coverage ratio provides a more comprehensive analysis of a company’s ability to meet its debt obligations, but it does not assess long-term debt obligations separately.
