Cash Coverage Ratio

What is Cash coverage ratio ?

Cash coverage ratio is used to measure the ability of a company to pay its interest expense or current liabilities using only cash and cash equivalents. It is a ratio to determine the cash solvency. It is a liquidity ratio.

How is Cash coverage ratio calculated ?

The cash coverage ratio is used in various forms.

 

Illustrations with solutions :

Objective 1 : To find the cash available to repay fixed expenses

When the objective is to find the cash available to repay fixed expenses like Interest on debt ( both short term and long term ) the formula for calculating the cash coverage ratio in this
scenario is

= ( EBIT + Non cash expenses )  / Interest expenses

= ( EBIT + Depreciation or Amortization expense ) / Interest expenses

 

Example :

Cashrich co. has EBIT of $ 500,000, Depreciation of $ 40,000 and Interest Expense of $ 30,000. Calculate the cash coverage ratio.

Solution :

As per the information provided in the question

EBIT = $ 500,000  ; Depreciation = $ 40,000   ;  Interest Expense = $ 30,000  ;

 

The cash coverage ratio is

= ( $ 500,000 + $ 40,000 ) / $ 30,000 = $ 540,000 / $ 30,000

= 18.00 ( when rounded off to two decimal places )

The firm’s cash coverage ratio = 18 times.

This implies that the company has 18 times the amount of cash required to pay its Interest expense.

 

Objective 2 : To find the cash available to repay the current liabilities

When the objective is to find the cash available to repay the current liabilities, the formula for calculating the cash coverage ratio shall be

= Cash and cash equivalents  / Current liabilities

Cash equivalents are short term assets and investments that can be converted into cash within a period of 90 days.

 

Example :

Cashjoy co. has Cash of $ 500,000, Short term marketable securities of $ 100,000 and Current liabilities of $ 150,000. Calculate the cash coverage ratio.

Solution :

As per the information provided in the question we have

Cash = $ 500,000  ; Short term marketable securities = $ 100,000   ; 

Current liabilities = $ 150,000 ;

 

The cash coverage ratio is calculated as follows :

= ( $ 500,000 + $ 1000,000 ) / $ 150,000 = $ 600,000 / $ 150,000

= 4.00 ( when rounded off to two decimal places )

The firm’s cash coverage ratio = 4 times.

This implies that the company has 4 times the amount of cash required to pay its Current liabilities.

Leave a Reply

Your email address will not be published.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

Debt RatioDebt Ratio

What is Debt Ratio ? Debt ratio is a leverage ratio used to quantify the percentage of Debt that is funded by assets of the company. It also known as