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Cash-to-Debt Ratio: How to calculate and interpret?

DEFINITION:

The Cash-to-Debt ratio or Cash Flow-to-Debt Ratio (in Finnish, Käteis-velkasuhde) tells investors about the capacity of a company to cover its total debt. It is used to measure the company's financial strength and financial healthy.

FORMULA for calculations:

\[ {Cash\ Flow\ to\ Debt\ Ratio} = {Cash\ Flow\ From\ Operations\over Total\ Debt} \]

WHERE:

  • Cash Flow from Operations = Cash, Cash Equivalents, Marketable Securities (cash flow statement data)
  • Total debt = Short term debt + Long term debt (balance sheet data)

Ratio can be expressed as a percentage or its equivalent decimal value:

  • the result in percentage indicates how much of a company's total debt will be retired.
  • the result in decimal value indicates the number of years it will take for the company to pay off all of its debts.

RESULT INTERPRETATION:

  • if the ratio is greater than 1, the company can pay off its debts using its cash, otherwise, the result smaller than 1 indicates that the company has more debts than the cash.
  • The higher the ratio the stronger the financial position of the business. Conversely, the lower the ratio the greater risk of payments default and the weaker financial footing of the business.

EXAMPLE:

Let's suppose, that the cash flow to debt ratio of the company is 15% or 0,15. Thus, we will have the following:

  • company could retire 15% of its total debt in one year, in case of all cash flow from operations would devote to debt repayment.
  • as a result, the company would roughly take 7 years (1/0.15 = 6,7) to repay all its debt.

It should be noted here that in practice, there is hardly any enterprise that will direct 100% of operating cash to repay the debts.

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