Cash Flow Coverage Ratio Basics (2024)

FAQs

Cash Flow Coverage Ratio Basics? ›

Typically, the cash flow coverage ratio for most businesses should be at least 1.5x. This means that there is at least $1.50 in operating cash flows to pay off every $1 of interest payments.

The Formula of the Cash Flow Coverage

On one hand, it can be calculated by dividing the Operating Cash Flows to the Total Debt of your company. On the other hand, you can add the EBIT (earnings before interest and taxed) to the depreciation and amortization, and then divide these to the total debt.

Usually, a healthy company has a cash ratio of 0.5 or more. Below that number, it can be surmised that the company is not using its assets well. On the other hand, if a company has a cash ratio of more than 1, it means that it is able to pay off its debts with ease while still having liquid assets left over.

The operating cash flow ratio is a measure of the number of times a company can pay off current debts with cash generated within the same period. A high number, greater than one, indicates that a company has generated more cash in a period than what is needed to pay off its current liabilities.

Interest coverage ratio: The ability of a company to pay the interest expense (only) on its debt. Debt service coverage ratio: The ability of a company to pay all debt obligations, including repayment of principal and interest. Cash coverage ratio: The ability of a company to pay interest expense with its cash balance.

Interest Coverage Ratio = EBIT / Interest Expense

An interest coverage ratio of two or higher is generally considered satisfactory.

Overall, an interest coverage ratio of at least two is the minimum acceptable amount. In most cases, investors and analysts will look for interest coverage ratios of at least three, which indicate that the business's revenues are reliable and consistent.

A good price-to-cash-flow ratio is any number below 10. Lower ratios show that a stock is undervalued when compared to its cash flows, meaning there is a better value in the stock.

A “good” free cash flow conversion rate would typically be consistently around or above 100%, as it indicates efficient working capital management. If the FCF conversion rate of a company is in excess of 100%, that implies operational efficiency.

What is a high cash flow coverage ratio? ›

A high ratio allows you to accelerate debt repayments so that you can use more of your profits later. If your cash flow coverage ratio is lower than 1, it's time to look at how you're using your resources to pay off debt. You will need to make other areas of operations more efficient to free up cash flows.

Generally, a good debt ratio is around 1 to 1.5. However, the ideal debt ratio will vary depending on the industry, as some industries use more debt financing than others.

Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.

To calculate the FCF ratio, you need to divide the free cash flow by the operating cash flow. You can find the operating cash flow in the cash flow statement and the capital expenditures in the cash flow statement or the income statement of a company.

Free Cash Flow = Net income + Depreciation/Amortization – Change in Working Capital – Capital Expenditure. Operating Cash Flow = Operating Income + Depreciation – Taxes + Change in Working Capital. Cash Flow Forecast = Beginning Cash + Projected Inflows – Projected Outflows = Ending Cash.

Cash Flow Coverage, CFC, is the amount of cash left after G&A and Draw (Distributions) to pay debt service. CFC can be calculated by taking pre-debt cash flow (after G&A and Draw) and dividing by the debt service. McDonald's guidelines call for a CFC ratio of 1.2 or greater.

The cash coverage ratio is useful for determining the amount of cash available to pay for a borrower's interest expense, and is expressed as a ratio of the cash available to the amount of interest to be paid. To show a sufficient ability to pay, the ratio should be substantially greater than 1:1.