**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.

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