What is '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. This ratio is a type of coverage ratio, and can be used to determine how long it would take a company to repay its debt if it devoted all of its cash flow to debt repayment. Cash flow is used rather than earnings because cash flow provides a better estimate of a company’s ability to pay its obligations. The ratio is less frequently calculated using EBITDA or free cash flow.

BREAKING DOWN 'Cash Flow-to-Debt Ratio'

While it is unrealistic for a company to devote all of its cash flow from operations to debt repayment, the cash flow-to-debt ratio provides a snapshot of the overall financial health of a company. A high ratio indicates that a company is better able to pay back its debt, and is thus able to take on more debt if necessary.

Another way to calculate the cash flow-to-debt ratio is to look at a company’s EBITDA rather than cash flow from operations. This option is used less often because it includes investment in inventory, and since inventory may not be sold quickly, it is not considered as liquid as cash from operations. Without further information about the make-up of a company’s assets, it is difficult to determine whether a company is as readily able to cover its debt obligations in the EBITDA method.

Free Cash Flow Instead of Cash Flow From Operations

Some analysts use free cash flow instead of cash flow from operations because that measure subtracts cash used for capital expenditures. Using free cash flow instead of cash flow from operations may, therefore, indicate that the company is less able to meet its obligations.

The cash flow-to-debt ratio examines the ratio of cash flow to total debt. Analysts sometimes also examine the ratio of cash flow to just long-term debt. This ratio may provide a more favorable picture of a company's financial health if it has taken on significant short-term debt. In examining either of these ratios, it is important to remember that they vary widely across industries. A proper analysis should compare these ratios with those of other companies in the same industry.

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