As with other financial calculations, some industries operate with higher or lower amounts of debt, which affects this ratio. Coverage ratios are used as a method to measure the ability of a company to pay its current financial obligations. Along with the cash coverage ratio, there are a variety of other coverage ratios that can be used.

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While the asset coverage ratio may include cash, it also considers other resources. The asset coverage ratio only considers a company’s ability to repay debts using total assets minus short-term liabilities. Net income, interest expense, debt outstanding, and total assets are just a few examples of financial statement items that should be examined. To ascertain whether the company is still a going concern, one should look at liquidity and solvency ratios, which assess a company’s ability to pay short-term debt (i.e., convert assets into cash). A coverage ratio, broadly, is a metric intended to measure a company’s ability to service its debt and meet its financial obligations, such as interest payments or dividends. The higher the coverage ratio, the easier it should be to make interest payments on its debt or pay depreciation recapture dividends.

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Therefore, ABC Co.’s cash coverage ratio of 2.0 clears that threshold. However, this ratio does not indicate how the company performs compared to its competitors or industry. However, there is an alternative formula for the cash coverage ratio. This alternative is more straightforward compared to the above option, as below. Similarly, the interest expense is also available in the income statement. Some of these figures may also be available in the notes to the financial statements.

1. Predictably, within months the restaurant goes bankrupt and closes its doors forever.
2. Once you’ve calculated EBIT, you‘ll need to add back any depreciation or amortization expenses.
3. This is similar to consumer lending practices where the lender wants the borrower to remain under a certain debt-to-income threshold.
4. Even though the company is generating a positive cash flow, it looks riskier from a debt perspective once debt-service coverage is taken into account.
5. Based on this information, lenders decide whether they should provide finance to borrowers.

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Invariably, your balance sheet always shows current liabilities separately from long-term liabilities. It only takes into consideration the ability of your business to pay interest expense. While many small businesses would find the cash ratio useful, only those with debt repayment and interest expenses will need to use the cash coverage ratio. When obtaining finance, most lenders consider the coverage ratios before deciding.

Formula: How to Calculate Current Cash Debt Coverage Ratio

Note that we also label the cash flow to debt ratio as the cash flow coverage ratio. The cash coverage ratio is not a ratio typically run by a small business bookkeeper. If you’re a sole proprietor or a very small business with no debt on the books, other accounting ratios are much more useful, such as current ratio or quick ratio. The cash coverage ratio focuses on whether a company has enough cash resources to cover interest expenses.

A ratio of one or above is indicative that a company generates sufficient earnings to completely cover its debt obligations. There may be a number of additional non-cash items to subtract in the numerator of the formula. For example, there may have been substantial charges in a period to increase reserves for sales allowances, product returns, bad debts, or inventory obsolescence. If these non-cash items are substantial, be sure to include them in the calculation.

It is in the same family as the metrics that include the current ratio and the quick ratio. However, it’s more restrictive because it measures only the available cash and cash equivalents, not other assets. Instead of using only cash and cash equivalents, the asset coverage ratio looks at the ability of a business to repay financial obligations using all assets instead of only cash or operating income. Instead of using only cash and cash equivalents, the asset coverage ratio looks at the ability of a business to repay financial obligations using all assets instead of only cash or operating income. The current cash debt coverage ratio should be used when analyzing a company’s ability to repay its current liabilities in the short-term (usually, within 12 months). The ultimate purpose of a current cash debt coverage ratio involves identifying whether or not the company can cover its debt with the current operating cash flow generation.