1. Debt Ratios: Introduction
  2. Debt Ratios: Overview Of Debt
  3. Debt Ratios: The Debt Ratio
  4. Debt Ratios: Debt-Equity Ratio
  5. Debt Ratios: Capitalization Ratio
  6. Debt Ratios: Interest Coverage Ratio
  7. Debt Ratios: Cash Flow To Debt Ratio

This coverage ratio compares a company's operating cash flow to its total debt. Operating cash flow is defined as the amount of cash generated by the company’s normal business operations.

As an example, take a manufacturing company that reports a net income of $100 million, with an operating cash flow of $150 million. The difference comes from adding to the net income depreciation expense of $150 million, subtracting increases in accounts receivable of $50 million, adding decreases in inventory of $50 million and subtracting decreases in accounts payable of $100 million.

Depreciation is an expense for accrual accounting purposes, but there is no cash outlay so it is added back to reported net income. Increases in accounts receivables denote increased revenues but result in no actual cash inflows, hence they are subtracted. A decrease in inventories would indicate that less money had been spent adding to inventories, hence the increase in cash flow. An increase in inventories would have been a reduction in cash flow. The decrease in accounts payables means that the firm paid down some of its payables, which is a use or reduction of cash.

Debt is the sum of short-term borrowings, the current portion of long-term debt and long-term debt.

This ratio provides an indication of a company's ability to cover total debt with its yearly cash flow from operations. The higher the percentage ratio, the better the company's ability to carry and service its total debt.


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