What is Cash Flow to Debt Ratio
Cash flow to debt ratio is a financial ratio that measures the company’s ability to pay off its liabilities by using the cash generated by the operating activities. The cash flow to debt ratio uses to determine the company’s solvency or the company’s ability to survive in the long run. The higher the cash flow to debt ratio, the better it is for the company’s financial health.
The cash flow to debt ratio is a comparison between the net cash of operating activities with the total liabilities of the company. The cash flow to debt ratio value of 1 means the company has the cash from the operation activity is exactly equal to the total liabilities.
The higher value of the cash flow to debt ratio indicates the higher company’s financial stability. Conversely, the lower ratio reflects that the company may have a financial stability issue due to the ability to repay debt.
The ratio is important for creditors and investors who want to make sure the company can pay its debts on time. This is because the cash flow to debt ratio is a coverage ratio that can be used to determine how long it would take a company to pay off debt if the company used all of its cash flow to pay off the debt.
Cash Flow to Debt Ratio Formula
The cash flow to debt ratio is calculated by dividing the company’s cash from operating activities by the company’s total debt while the total debt is represented by average total liabilities, or the following cash flow to debt ratio formula:
Cash flow to debt ratio = Cash flow provided by operating activities / Average total liabilities
or
Cash flow to debt ratio = Cash flow provided by operating activities / Total liabilities
Where:
- Average total liability = (Total liabilities at the beginning of the year + Total liabilities at the end of the year) / 2
For example, let’s say the Feriors company has a total liability of $30,000 and cash flow from the operation of $70,000 for this financial year.
Cash flow to debt ratio = $70,000 / $30,000 = 2.33 times (or 233%)
FAQs
The cash flow to debt ratio is a financial ratio that measures the company’s ability to pay off its liabilities by using the cash generated by the operating activities.
Cash flow to debt ratio = Cash flow provided by operating activities / Total liabilities
The higher value of the cash flow to debt ratio indicates the higher company’s financial stability.
