What is a Cash Coverage Ratio?
Overview: Cash Coverage Ratio
The Cash Coverage Ratio measures a company's ability to cover its interest expenses with its available cash flow. It is an important liquidity metric, often used by lenders and investors to assess financial health and risk.
Formula:
Key Components:
- EBIT (Earnings Before Interest and Taxes): Measures operating profitability before considering financing costs.
- Depreciation & Amortization: These are non-cash expenses added back since they don’t affect actual cash flow.
- Interest Expense: Represents the cost of debt financing.
Interpretation:
- Higher Ratio (>1): Indicates the company generates sufficient cash flow to cover its interest obligations, reducing default risk.
- Lower Ratio (<1): Suggests potential financial distress, as the company may struggle to meet interest payments.
Why It Matters:
- Lenders use it to evaluate creditworthiness.
- Investors assess financial stability before investing.
- Companies monitor it to ensure they maintain a healthy debt service capacity.
