Cash flow to debt ratio

Category:Ratios
Alternative names: cash flow coverage ratio debt service coverage ratio DSCR

What is Cash Flow to Debt Ratio

The cash flow to debt ratio is an indicator of the ability of a company to service its debt (pay interest and principle amount when due) from its operating cashflows. This ratio tells the number of times the financial obligations of a company are covered by its operating cashflows. In other words Cash Flow to Debt Ratio shows how long it will take for the company to repay all of its debt if it decides to use all of its operating cashflows.

How to calculate Cash Flow to Debt Ratio (formula)

The cashflow to debt ratio is calculated by dividing the total debt of the company (witch can be found on the company balance sheet) by the company cash flow from operations (witch can be found on the company cashflow statement).

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

Some versions of the cashflow to debt ratio formula use free cashflow instead of cashflow from operation because free cashflows exclude cash that is used for capital expenditures so this version of the formula is even more conservative about the company ability to pay its debt. Cash flow from investing activities is also generally not used in the calculation since investing activities are not part of the business’ core cash-generating activities.

What is a good Cash Flow to Debt Ratio number

Generally the higher the ratio the better, a ratio equal to one or more usually means that the company is in good financial health and can easily meets its financial obligations bu using its cashflow. A ratio significantly lower than one is an indicator of potential financial distress for the company.

To estimate if the ratio is too high or low, a financial analyst should take in consideration the past performance of the company and compare it with other companies in the same sector and industry.

Why is Cash Flow to Debt Ratio important

The Cash Flow Coverage ratio is an important indicator of the liquidity position of a company and its one of the coverage ratios used in the financial world to check the health of the company. It’s a way for analysis to evaluate the company debt-paying capacity. This ratio is also often used by the banks to decide whether to make or refinance any loan.