Cash Flow-to-Debt Ratio
What Is the Cash Flow-to-Debt Ratio?
The cash flow-to-debt ratio is the ratio of a company's cash flow from operations to its total debt. All this ratio is a type of coverage ratio and can be utilized to determine what amount of time it would require for a company to repay its debt in the event that it dedicated its cash flow to debt repayment. Cash flow is utilized instead of earnings since cash flow gives a better estimate of a company's ability to pay its obligations.
The Formula for the Cash Flow-to-Debt Ratio
The ratio is less as often as possible calculated utilizing EBITDA or free cash flow.
Everything the Cash Flow-to-Debt Ratio Can Say to You?
All while it is unreasonable for a company to commit its cash flow from operations to debt repayment, the cash flow-to-debt ratio gives a snapshot of the overall financial health of a company. A high ratio shows that a company is better able to pay back its debt, and is subsequently able to assume more debt if important.
One more method for computing the cash flow-to-debt ratio is to take a gander at a company's EBITDA instead of the cash flow from operations. This option is involved less frequently in light of the fact that it remembers investment for inventory, and since inventory may not be sold rapidly, it isn't thought of as liquid as cash from operations.
Minus any additional data about the make-up of a company's assets, it is challenging to determine whether a company is as promptly able to cover its debt obligations utilizing the EBITDA strategy.
The Difference Between Free Cash Flow and Cash Flow From Operations
A few analysts use free cash flow rather than cash flow from operations since this measure deducts cash utilized for capital expenditures. Utilizing free cash flow rather than cash flow from operations may, in this manner, demonstrate that the company is less able to meet its obligations.
The cash flow-to-debt ratio analyzes the ratio of cash flow to total debt. Analysts once in a while likewise look at the ratio of cash flow to just long-term debt. This ratio might give a better image of a company's financial wellbeing in the event that it has assumed huge short-term debt. In looking at both of these ratios, it is important to recollect that they differ widely across industries. A legitimate analysis ought to contrast these ratios and those of different companies in a similar industry.
Illustration of How to Use the Cash Flow-to-Debt Ratio
Accept that ABC Widgets, Inc. has total debt of $1,250,000 and cash flow from operations for the extended time of $312,500. Compute the company's cash flow to debt ratio as follows:
The company's ratio aftereffect of 25% shows that, expecting it has stable, consistent cash flows, it would require around four years to repay its debt since reimbursing 25% every year would be able. Isolating the number 1 by the ratio result (1/.25 = 4) affirms that it would require four years to repay the company's debt.
Assuming that the company had a higher ratio result, with its cash flow from operations higher relative to its total debt, this would show a financially more grounded business that could increase the dollar amount of its debt repayments if necessary.
Highlights
- All the cash flow-to-debt ratio demonstrates what amount of time it would require for a company to pay off its debt in the event that it involved its all operating cash flow for debt repayment (albeit this is an extremely ridiculous scenario).
- The cash flow-to-debt ratio looks at a company's created cash flow from operations to its total debt.
