MSG Team's other articles

12266 Advantages and Disadvantages of Forex Market

Advantages of Forex Market The biggest financial market in the world is the biggest market because it provides some advantages to its participants. Some of the major advantages offered are as follows: Flexibility Forex exchange markets provide traders with a lot of flexibility. This is because there is no restriction on the amount of money […]

9600 How Do Pension Funds Influence Economic Growth?

Pension funds have witnessed a dramatic increase in the number of assets that they control. This increase has been the result of an ever-increasing workforce that has been diligently contributing to their financial future. The funds being managed by pension funds have increased both in developed as well as developing nations. Many developing nations are […]

12705 Challenges to Investment Banking Business

Investment banking has traditionally been a lucrative business. Investment bankers have always been in the news for the excessive amount of money that they made while the rest of the world was struggling. However, the relentless negative publicity that the industry has received in the past has changed the way it functions. Also, external circumstances […]

11867 Dividend Discount Model: Gordon Growth Rate

In the previous article, we became aware that the value of a stock can be split into two parts. One part is the horizon period i.e. the period chosen by the analyst for which they believe they can accurately forecast the financials of the company and therefore its dividends. This part remains the same when […]

10891 Ratio Analysis in Personal Finance

Ratio analysis is considered to be very important when it comes to making financial investments. There are many retail investors who know the value of retail investments. As a result, they also routinely perform a ratio analysis for companies that they invest in. However, surprisingly, a lot of these analysts do not perform a ratio […]

Search with tags

  • No tags available.

Formula

Cash Flow to Debt Ratio = Operating Cash Flow/Total Debt

Meaning

The cash flow to debt ratio tells investors how much cash flow the company generated from its regular operating activities compared to the total debt it has. For instance if the ratio is 0.25, then the operating cash flow was one fourth of the total debt the company has on its books. This debt includes interest payments, principal payments and even lease payments to cover off balance sheet financing.

Assumptions

  • Does Not Cover Amortization: The cash flow to debt ratio assumes interest and principle payments will be paid in the same manner over the years as they have been paid in this year. This assumption is implicit in the fact that while calculating total debt (denominator) we take the interest and principal payments from the present year financial statements.

    However, this may not be the case. Companies have access to a variety of financing schemes. Some of these schemes include interest only payments, bullet payments, balloon payments, negative amortization, so on and so forth. In such innovative amortization, there may be years when the company has to pay a lot of interest and other years when it has to pay none. Hence the present years figures may not be indicative of the future.

  • Does Not Cover Lease Increment: Once again, the ratio takes the lease numbers from the financial statements of the current year. However, most lease contracts nowadays have lease increment provisions in them. This means that every year the lease may go up by a certain percentage. The ratio does not cover this aspect.

Interpretation

  • Creditworthiness: Cash flow to debt ratio is the true measure of the creditworthiness of a firm. This is because a company has to pay its interest and retire its debt by paying cash. They cannot pass on the earnings that they may have recorded on accrual basis to creditors to satisfy their claims.

    Earlier analysis used earnings because at that time credit periods were small or nonexistent and therefore earnings to some extent meant cash flow. However, with the proliferation of credit, the distinction has been widened.

    A company may book earnings immediately and not receive cash for years on end. Thus creditors have their eyes set on cash flow ratios.

  • Analysis of the Past: The cash flow to debt ratio thus becomes an analysis of how comfortably the company paid its obligations in the past. The future may or may not be similar. Analysts have to make adjustments to this ratio to make it more meaningful.

Article Written by

MSG Team

An insightful writer passionate about sharing expertise, trends, and tips, dedicated to inspiring and informing readers through engaging and thoughtful content.

Leave a reply

Your email address will not be published. Required fields are marked *

Related Articles

What are Common Size Statements ?

MSG Team

Cash Ratio – Meaning, Formula and Assumptions

MSG Team