Cash Debt Coverage Ratio

This is a complete guide on how to calculate Cash Debt Coverage Ratio with in-depth analysis, example, and interpretation. You will learn how to use its formula to examine a company’s ability to service its debt.

Definition - What is Cash Debt Coverage Ratio?

The Cash Debt Coverage Ratio, or the cash flow to debt ratio, looks at the relationship between the operating cash flow of a company to its total liabilities and implies what the actual ability of the business to pay back its debt from its operations is.

This liquidity ratio is generally regarded as being better when it is high (over 1.0) or at an ideal level of 1:1.This would be seen as very comfortable as it suggests the company has a strong capability of paying off its total debt using the cash flow from its operations.

And this serves as a positive indicator for both investors and creditors.

A cash debt coverage ratio below 1.0 or close to 0 on the other hand, would serve as a strong warning that the financial condition of the company is bleak.



The formula to measure the cash debt coverage is as follows:

Cash Debt Coverage Ratio Formula

Cash Debt Coverage Ratio = Net Cash Provided By Operating Activities / Total Debt

So divide the net cash of the business that is provided by its operating activities i.e. operating cash flow by the total debt of the business.

You can easily find these numbers on a company’s balance sheet and cash flow statement.

As you can see in the formula, this ratio compares a company’s operating cash flow with its total liabilities.

That’s why this efficiency ratio is also reffered to as the cash to total debt ratio.


Okay now let’s consider a quick example so you can see exactly how to compute this ratio in real life.

At December 31st 2015, GLK Company had operating cash flows as recorded in its statement of cash flows of $735M and total debt of $1,003M.

To determine the cash flow to debt, we need to substitute into the formula:

Cash Debt Coverage Ratio Calculation

The workings show that GLK Company operates at a cash to debt coverage level of 0.73 (or 73%).

Interpretation & Analysis

In our previous example, although a ratio of 0.73 would seem to be at a reasonable level i.e. closer to 1.0 than zero and over 0.5, typically, a result over 0.8 would be the most desireable and over 1.0, best.

This would be a solid implication that GLK Company could pay off its debts from the cash flow of its own operations.

So what is a good cash debt coverage ratio?

In general, a cash debt coverage of over 1.5 is considered a good ratio result, which means that the company’s operating cash flow is 1.5 times greater than its total liabilities.

That's to say, the company can easily cover its debt obligations by using its current operating cash flow.

Cautions & Further Explanation

It is imperative that the figure is not used in isolation else it can provide flawed analysis.

Typically, it is ideal if you use a variety of ratios to gain a clear insight into the profitability and performance of a company.

Comparisons should be made between companies within the same industry and also between current ratio results and previous ratio results.

A high ratio of 1.0 might seem ideal but if the company were running at a cash debt coverage of 1:1 the previous year, we would need to look to understand what had happened to make the company's ability to pay back its debt, decline.

Alternatively, a low ratio of 0.7 (or 70%) might seem fair and maybe even off-putting to potential investors.

Yet if the previous year showed a ratio of 0.3 (30%), we would be inclined to assume the company is becoming much more able to pay off its debts based on its operations.

Hung Nguyen

Entrepreneur, independent investor, instructor and a visionary of my team here. I've been playing with stocks and sharing my knowledge to the world. The stock market is cool, and I love it!

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