Cash Flow Coverage Ratio
Cash flow coverage ratio is the liquidity ratio which is used to calculate the ability of a company to pay off its obligation with its operating cash flow. This calculation shows how a firm easily pays off its debt from the cash flow of the company.
The cash flow coverage ratio, for the obligation of the money how much money company, have. This is used to shows the current liquidity. Also, it is used to find that how many time over earning can cover the current obligation such as rent, Bills, and interest.
Definition: What is The Cash Flow Coverage Ratio?
For the broad overview of any company investor, creditor and analyst use cash flow coverage ratio. because this ratio they can know the operating efficiency of the company.
When bank issue loan for business then before this bank check the cash flow coverage ratio of that company for the determination of the repayment risk.
Cash Flow Coverage Ratio Formula (s)
Cash flow coverage ratio which depends upon on the amount of the cash flow. there are 2 formulas for this ratio but generally, it can be calculated by dividing the operating cash flow by total debt that is
Cash flow coverage ratio = operating cash flow/total debt
Cash flow coverage ratio=(EBIT+Depreciation+Amortiztion)/total debt
Now take the example and find cashflow coverage ratio. (What is Ebit?)
Cash Flow Coverage Ratio Example
Let company “A” apply for a loan to build the manufacturing plant. For paying loan lender to analyze the financial statement of the company A to find the ability of repayment of the loan.
By monitoring, its lender determines the appropriate loan term for the company.
For finding the ability of repayment of the loan lender calculates the cash flow coverage ratio of the company for last year. Total operating cash flow of company A for last year is $80,000,000 and total payable debt was $38,000,000.
Cash flow coverage ratio=80,000,000/38,000,000
By using the second formula of cashflow credit ratio analyst again review this
Cash coverage ratio = 2
From the above analyzer determine that the company generate twice cash flow then its need to cover the existing obligation. After this calculation Lender determine that the company’s ability of repayment loan.
Analysis and interpretation
Cash flow coverage ratio determines business efficiency in the market. Some company has high debt and some have high debt which affects the cash flow coverage.
If the ratio is low then it is very risky for the lender to pay the loan to low cash flow coverage ratio. but on the number of assets, low ratio companies can get loans.
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