## 3.5. Cash debt coverage ratio

Cash debt coverage ratio shows how much of the company’s total liabilities can be covered (paid) with net cash from operating activities. In other words, this ratio is one of the measures of the company’s financial flexibility and stability. This ratio is calculated by dividing net cash provided by operating activities by the average total liabilities.

Cash Debt Coverage Ratio Formula

Cash debt coverage ratio is calculated by dividing net cash provided by operating activities by the average total liabilities (i.e., current liabilities plus long-term liabilities):

 Cash Debt Coverage Ratio = Net Cash Provided by Operating Activities Average Total Liabilities

Cash Debt Coverage Ratio Example

Let’s go back to our example of Friends Company and use data from the statements of cash flows and balance sheets available at the end of this tutorial. The cash debt coverage ratio at the end of fiscal year 20X9 can be calculated as follows:

 Cash Debt Coverage Ratio = \$4,870 = 0.52 [(\$4,200 + \$6,000) + (\$5,300 + \$3,220)] 2

Cash debt coverage ratio of 0.52 indicates that for every dollar of total liabilities there were 52 cents of net cash provided by operating activities. In other words, Friends Company can meet (or cover) 52% of its liability obligations with net cash provided by operating activities.

Important Notes

• Cash debt coverage ratio of 1 is considered to be a reasonably good indicator of the company’s financial stability. In general, a high level of this ratio is considered to be favorable by creditors and investors. Contrary, a low cash debt coverage debt ratio implies the company may have financial stability problems in the near future because it will not be able to sustain debt payments.
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