Investing for Beginners - Cash Flow Coverage Ratio

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Cash Flow Coverage Ratio

Cash flow coverage ratio measures company’s ability to repay its debt. This ratio compares operating cash flow of the company to its debts. If ratio is low (lower than 0.2), it may indicate potential solvency problems that would occur if market conditions would turn in to unfavorable ones.

Companies in stable sectors may have lower cash flow coverage ratio than companies in very volatiles sectors as construction or automotive (high debt level for these sectors is more dangerous).

Cash flow coverage ratio formula

Cash flow coverage ratio = (Net income + Depreciation + Amortization) / Total debt

Cash flow coverage ratio = Operating cash flow / Total debt

* Theoretically, ‘operating cash flow’ is not the same as ‘net income + depreciation + amortization’ but this measure (NI+DA) is the core of operating cash flow. Both measures can be used in practice, but ‘net income + depreciation + amortization’ can be more appropriate ratio if ‘net income’ is not affected by one-off costs or income.

There are more similar coverage ratios as ‘interest coverage ratio’.

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Cash Flow Coverage Ratio