Cash Coverage Ratio Calculator
The Cash Coverage Ratio is a financial solvency ratio that measures a company's ability to generate enough cash to cover its interest and tax obligations. It indicates how many times a company's operating cash flow can cover these mandatory payments.
Enter the values for Operating Cash Flow, Interest Paid, and Taxes Paid below. Ensure consistent currency units.
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Understanding the Cash Coverage Ratio
What is it?
The Cash Coverage Ratio is a measure of a company's ability to meet its debt obligations using its operating cash flow. It specifically looks at how well operating cash flow covers the interest and taxes that the company must pay.
Formula
The formula for the Cash Coverage Ratio is:
Cash Coverage Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
Where:
- Operating Cash Flow: Cash generated from normal business operations.
- Interest Paid: Cash outflow for interest payments on debt.
- Taxes Paid: Cash outflow for income tax payments.
Interpretation
A higher ratio is generally preferred, as it indicates a company has more cash flow available to cover its interest and tax expenses. A ratio significantly greater than 1 suggests strong solvency. A ratio near or below 1 could indicate potential difficulties in meeting these obligations.
Cash vs. Earnings
This ratio uses cash flow (Operating Cash Flow) rather than accounting earnings (like EBIT or EBITDA) in the numerator. This is often considered a more conservative measure of a company's ability to pay debts, as cash flow is less easily manipulated than reported earnings.
Related Ratio: Interest Coverage Ratio
The Interest Coverage Ratio uses earnings before interest and taxes (EBIT) or EBITDA in the numerator and only interest expense in the denominator (EBIT / Interest Expense). The Cash Coverage Ratio is similar but focuses purely on cash movements and includes taxes in the denominator, providing a stricter view of cash available to cover mandatory payments.
Cash Coverage Ratio Examples
Here are 10 examples illustrating the calculation and interpretation:
Example 1: Healthy Company
Scenario: Company A has strong cash flow.
Known Values: Operating Cash Flow = $500,000, Interest Paid = $50,000, Taxes Paid = $20,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $500,000 / ($50,000 + $20,000) = $500,000 / $70,000
3. Result: Ratio ≈ 7.14
Interpretation: Company A's operating cash flow is over 7 times the amount needed to cover its interest and tax payments, indicating strong cash solvency.
Example 2: Borderline Company
Scenario: Company B has just enough cash flow.
Known Values: Operating Cash Flow = $120,000, Interest Paid = $80,000, Taxes Paid = $40,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $120,000 / ($80,000 + $40,000) = $120,000 / $120,000
3. Result: Ratio = 1.00
Interpretation: Company B's operating cash flow is just enough to cover its interest and tax payments. This indicates a tight cash position and potential risk if cash flow decreases.
Example 3: Company with Difficulty
Scenario: Company C is struggling to cover payments.
Known Values: Operating Cash Flow = $75,000, Interest Paid = $60,000, Taxes Paid = $30,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $75,000 / ($60,000 + $30,000) = $75,000 / $90,000
3. Result: Ratio ≈ 0.83
Interpretation: Company C's operating cash flow is less than what is needed to cover its interest and tax payments. This indicates a high risk of default or difficulty meeting obligations.
Example 4: Company with No Debt or Taxes
Scenario: A new company with no debt and tax liability period.
Known Values: Operating Cash Flow = $10,000, Interest Paid = $0, Taxes Paid = $0.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Denominator is $0 + $0 = $0.
3. Result: Undefined (Division by zero).
Interpretation: The ratio is undefined when the denominator (Interest + Taxes) is zero. This situation usually implies there are no debt-servicing or tax obligations to cover from operations in this period, making the ratio less informative about solvency in the traditional sense.
Example 5: Company with Zero Taxes
Scenario: Company E operates in a tax-exempt period or has tax credits.
Known Values: Operating Cash Flow = $300,000, Interest Paid = $100,000, Taxes Paid = $0.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $300,000 / ($100,000 + $0) = $300,000 / $100,000
3. Result: Ratio = 3.00
Interpretation: Company E can cover its interest payments 3 times over with operating cash flow. Taxes paid are zero in this specific period.
Example 6: Company with Zero Interest Payments
Scenario: Company F is debt-free but pays taxes.
Known Values: Operating Cash Flow = $150,000, Interest Paid = $0, Taxes Paid = $50,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $150,000 / ($0 + $50,000) = $150,000 / $50,000
3. Result: Ratio = 3.00
Interpretation: Company F can cover its tax payments 3 times over with operating cash flow. Interest paid is zero as they have no debt.
Example 7: Company with Negative Operating Cash Flow
Scenario: Company G is experiencing operational losses.
Known Values: Operating Cash Flow = -$100,000, Interest Paid = $20,000, Taxes Paid = $10,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = -$100,000 / ($20,000 + $10,000) = -$100,000 / $30,000
3. Result: Ratio ≈ -3.33
Interpretation: A negative ratio means the company's operations are consuming cash rather than generating it, making it impossible to cover interest and tax payments from operations alone. This is a serious red flag.
Example 8: Company with High Debt Burden
Scenario: Company H has significant interest payments.
Known Values: Operating Cash Flow = $400,000, Interest Paid = $250,000, Taxes Paid = $50,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $400,000 / ($250,000 + $50,000) = $400,000 / $300,000
3. Result: Ratio ≈ 1.33
Interpretation: Company H can cover its combined interest and tax payments, but with a relatively low margin (1.33 times). This suggests a high debt burden relative to its operating cash flow.
Example 9: Decimal Values
Scenario: Using precise decimal values from statements.
Known Values: Operating Cash Flow = $155,500.75, Interest Paid = $12,345.60, Taxes Paid = $8,765.40.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $155,500.75 / ($12,345.60 + $8,765.40) = $155,500.75 / $21,111.00
3. Result: Ratio ≈ 7.36
Interpretation: The company has a healthy ratio, capable of covering its obligations more than 7 times, even with specific decimal figures.
Example 10: Evaluating a Startup
Scenario: A startup in a growth phase with some debt.
Known Values: Operating Cash Flow = $50,000, Interest Paid = $15,000, Taxes Paid = $5,000.
1. Formula: Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid)
2. Calculation: Ratio = $50,000 / ($15,000 + $5,000) = $50,000 / $20,000
3. Result: Ratio = 2.50
Interpretation: The startup's operating cash flow is 2.5 times its required interest and tax payments, which is a reasonable position given its stage, showing it can currently service these costs from operations.
Important Considerations
While the Cash Coverage Ratio is valuable, consider:
- Context: Compare the ratio to industry benchmarks and the company's historical performance.
- Consistency: Use data from the same period and consistent accounting methods.
- Other Ratios: Analyze this ratio alongside other liquidity and solvency metrics for a complete picture.
- Non-Cash Items: Operating Cash Flow includes adjustments for non-cash items (like depreciation), which provides a different perspective than accrual-based earnings.
Frequently Asked Questions about the Cash Coverage Ratio
1. What does the Cash Coverage Ratio measure?
It measures a company's ability to cover its interest and tax obligations using the cash generated from its core business operations (Operating Cash Flow).
2. What is the formula for the Cash Coverage Ratio?
The formula is: Cash Coverage Ratio = Operating Cash Flow / (Interest Paid + Taxes Paid).
3. Why use Operating Cash Flow instead of Net Income?
Operating Cash Flow provides a clearer picture of the actual cash generated by the business, which is less affected by non-cash accounting entries compared to Net Income, making it a more conservative measure of debt-servicing ability.
4. What is considered a "good" Cash Coverage Ratio?
There's no single universal "good" number; it varies by industry. However, a ratio significantly above 1 (e.g., 1.5 or higher) is generally seen as healthy, indicating the company has sufficient operating cash flow buffer to meet its obligations.
5. What does a ratio less than 1 indicate?
A ratio below 1 means that the company's operating cash flow is insufficient to cover its mandatory interest and tax payments for the period, suggesting potential liquidity problems or reliance on external financing to meet these obligations.
6. Can the ratio be negative?
Yes, if Operating Cash Flow is negative (meaning operations are consuming cash), while Interest Paid or Taxes Paid (or both) are positive, the ratio will be negative. This is a strong indicator of financial distress.
7. What happens if Interest Paid + Taxes Paid is zero?
If the denominator (Interest Paid + Taxes Paid) is zero, the ratio is mathematically undefined (division by zero). This occurs if the company has no interest-bearing debt and pays no taxes in the reporting period.
8. Is this ratio useful for all types of companies?
It's most relevant for companies with significant debt and tax obligations. For companies with no debt or unique tax situations, other solvency ratios might be more informative.
9. How does it relate to the Interest Coverage Ratio?
Both measure ability to cover debt payments. Interest Coverage uses earnings (like EBIT) and only covers interest. Cash Coverage uses cash flow (OCF) and covers both interest and taxes, offering a stricter, cash-based perspective.
10. Where do I find the numbers for this ratio?
Operating Cash Flow is found on the Statement of Cash Flows. Interest Paid and Taxes Paid can often be found on the Statement of Cash Flows or derived from the Income Statement and footnotes, though the cash flow statement values are preferred for this ratio.
