Funds From Operations (FFO) to Total Debt Ratio

What Is Funds From Operations (FFO) to Total Debt Ratio?

The funds from operations (FFO) to total debt ratio is a leverage ratio that a credit rating agency or an investor can use to assess a company's financial risk. The ratio is a measurement contrasting earnings from net operating income plus depreciation, amortization, deferred income taxes, and other noncash things to long-term debt plus current maturities, commercial paper, and other short-term loans. Costs of current capital undertakings are excluded from total debt for this ratio.

Formula and Calculation of Funds From Operations (FFO) to Total Debt Ratio

FFO to total debt is calculated as:

Free cash flow/Total debt

Where:

• Free cash flow is net operating income plus depreciation, amortization, deferred income taxes, and other noncash things.
• Total debt is all long-term debt plus current maturities, commercial paper, and short-term loans.

What Funds From Operations (FFO) To Total Debt Ratio Can Tell You

Funds from operations (FFO) is the measure of cash flow created by a real estate investment trust (REIT). The funds incorporate money the company gathers from its inventory sales and services it gives to its customers. Generally Accepted Accounting Principles (GAAP) require REITs to depreciate their investment properties after some time utilizing one of the standard depreciation methods, which can distort the true performance of the REIT. This is on the grounds that numerous investment properties increase in value over the long haul, making depreciation mistaken in portraying the value of a REIT. Depreciation and amortization must, along these lines, be added back to net income to accommodate this issue.

The FFO to total debt ratio measures the ability of a company to pay off its debt utilizing net operating income alone. The lower the FFO to total debt ratio, the more leveraged the company is. A ratio lower than 1 shows the company might need to sell a portion of its assets or take out extra loans to keep above water. The higher the FFO to total debt ratio, the more grounded the position the company is in to pay its debts from its operating income, and the lower the company's credit risk.

Since debt-funded assets generally have valuable lives greater than a year, the FFO to total debt measure isn't intended to check whether a company's annual FFO covers debt completely, for example a ratio of 1, yet rather, whether it has the capacity to service debt inside a prudent time period. For instance, a ratio of 0.4 suggests the ability to service debt completely in 2.5 years. Companies might have resources other than funds from operations for repaying debts; they could take out an extra loan, sell assets, issue new bonds, or issue new stock.

For corporations, the credit agency Standard and Poor's considers a company with a FFO to total debt ratio of more than 0.6 to have negligible risk. A company with unobtrusive risk has a ratio of 0.45 to 0.6; one with intermediate-risk has a ratio of 0.3 to 0.45; one with huge risk has a ratio of 0.20 to 0.30; one with aggressive risk has a ratio of 0.12 to 0.20; and one with high risk has a FFO to total debt ratio below 0.12. Nonetheless, these standards fluctuate by industry. For instance, an industrial (manufacturing, service, or transportation) company could require a FFO to total debt ratio of 0.80 to earn an AAA rating, the highest credit rating.

Limitations of Using FFO to Total Debt Ratio

FFO to total debt alone doesn't give sufficient data to choose a company's financial standing. Other related, key leverage ratios for assessing a company's financial risk incorporate the debt to EBITDA ratio, which lets investors know how it would require for the company to repay its debts, and the debt to total capital ratio, which lets investors know how a company is financing its operations.

Highlights

• Funds from operations (FFO) to total debt is a leverage ratio that is utilized to evaluate the risk of a company, real estate investment trusts (REITs) specifically.
• The FFO to total debt ratio measures the ability of a company to pay off its debt utilizing net operating income alone.
• The lower the FFO to total debt ratio the more leveraged the company is, where a ratio below one demonstrates the company might need to sell a portion of its assets or take out extra loans to remain in business.