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

By Richard Loth (Contact | Biography)

This coverage ratio compares a company's operating cash flow to its total debt, which, for purposes of this ratio, is defined as 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 its total debt.

Formula:


Components:

As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings had net cash provided by operating activities (operating cash flow as recorded in the statement of cash flows) of $878.20 (cash flow statement), and total debt of only $1,036.80 (balance sheet). By dividing, the equation provides the company, in the Zimmer example, with a cash flow to debt ratio of about 85%.

Variations:
A more conservative cash flow figure calculation in the numerator would use a company's free cash flow (operating cash flow minus the amount of cash used for capital expenditures).

A more conservative total debt figure would include, in addition to short-term borrowings, current portion of long-term debt, long-term debt, redeemable preferred stock and two-thirds of the principal of non-cancel-able operating leases.

Commentary:
In the case of Zimmer Holdings, their debt load is higher than their operating cash flows, giving it a ratio of less than one, however the percentage (being above 80%) is considered high. In this instance, this circumstance would indicate that the company has ample capacity to cover it's debt expenses with its operating cash flow.

Under more typical circumstances, a high double-digit percentage ratio would be a sign of financial strength, while a low percentage ratio could be a negative sign that indicates too much debt or weak cash flow generation. It is important to investigate the larger factor behind a low ratio. To do this, compare the company's current cash flow to debt ratio to its historic level in order to parse out trends or warning signs.

More cash flow to debt relationships are evidenced in the financial positions of IBM and Merck, which we'll use to illustrate this point. In the case of IBM, its FY 2005 operating cash amounted to $14.9 billion and its total debt, consisting of short/current long-term debt and long-term debt was $22.6 billion. Thus, IBM had a cash flow to debt ratio of 66%. Merck's numbers for FY 2005 were $7.6 billion for operating cash flow and $8.1 billion for total debt, resulting in a cash flow to debt ratio of 94%.

If we refer back to the Capitalization Ratio page, we will see that Merck had a relatively low level of leverage compared to its capital base. Thus, it is not surprising that its cash flow to debt ratio is very high.

Proceed to the next chapter on Operating Performance Ratios here.
Or, click here to return to the Financial Ratio Tutorial main menu.


Related Articles
  1. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  2. Investing

    Analyzing General Electric's Debt Ratios in 2016 (GE)

    Evaluate GE's debt picture using the most important metrics for a large-cap conglomerate, including the debt-to-equity (D/E) ratio and the interest coverage ratio.
  3. Investing

    Analyze Cash Flow The Easy Way

    Find out how to analyze the way a company spends its money to determine whether there will be any money left for investors.
  4. Investing

    Free Cash Flow Yield: The Best Fundamental Indicator

    Cash in the bank is what every company strives to achieve. Find out how to determine how much a company is generating and keeping.
  5. Investing

    Fundamental Case Study: Is Amazon's Cash Flow Actually Solid? (AMZN)

    Review Amazon's cash flow situation, including its free cash flow yield, operating cash flow from organic growth and cash flow from debt financing.
  6. Investing

    Debt Ratio

    The debt ratio divides a company’s total debt by its total assets to tell us how highly leveraged a company is—in other words, how much of its assets are financed by debt. The debt component ...
  7. Investing

    Calculating Long-Term Debt to Total Assets Ratio

    A company’s long-term debt to total assets ratio shows the percentage of its assets that are financed with long-term debt.
  8. Investing

    Analyzing IBM's Debt Ratios in 2016 (IBM)

    Look over the debt ratios for the IBM Corporation, such as its debt-to-equity ratio, its interest coverage ratio and its cash flow to debt ratio.
  9. Investing

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  10. Investing

    Cash Flow From Investing

    Cash flow analysis is a critical process for both companies and investors. Find out what you need to know about it.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center