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Operating Cash to Debt Ratio

Evaluating a business' ability to service debt with cash

What is the Operating Cash to Debt Ratio?

The Operating Cash to Debt Ratio measures the percentage of a company’s total debt that is covered by its operating cash flow for a given accounting period. The operating cash flow refers to the cash that a company generates through its operating activities, and usually represents the biggest stream of cash that a company generates.

The Operating Cash to Debt Ratio can be used to assess a company’s probability of defaulting on its interest payments. Generating a  lot of cash relative to how much debt a company indicates that  company is in a good position to repay its debts, and is thus deemed a safer debt investment by creditors.

 

Operating Cash to Debt Ratio - Summary

 

A high ratio would mean that a company likely has a lower chance of defaulting on its loans, making it a safer investment opportunity for debt providers. Conversely, a low ratio would mean that a company has a higher chance of defaulting as it has less cash available to dedicate to debt repayments.

 

How can we calculate the Operating Cash to Debt Ratio?

The Operating Cash to Debt ratio can be calculated by dividing a company’s cash flow from operations by its total debt. The formula to calculate the ratio is:

 

Operating Cash to Debt Ratio - Formula

 

Where:

Cash Flow from Operations – refers to the cash flow that the business generated through its operating activities. This number can be found on a company’s cash flow statement

Total Debt – refers to the total debt that a company has to date, and can be found by adding  up the company’s short term debt and its ling term debt. Both of these figures can be found on the company;s balance sheet.

Generally speaking, a high OC to Debt ratio would indicate that a company is fairly mature, as it is generating a lot of cash from its operating activities. This contrasts with startups, which often times rely on their financing to generate cash flows (i.e are not yet self-sustaining). Thus, debt providers would typically prefer to lend money to companies with a high OC to Debt ratio since such companies are likely mature, generate steady cash flows from their operations, and are likely not overly leveraged.

 

Operating Cash to Debt Ratio Example

Bill’s Baguette’s wants to calculate its Operating Cash to Debt Ratio in order to gain a better understanding of where it stands in the industry with regards to its cash flow generation.  Below are snippets from the business’ financial statements:

 

Operating Cash to Debt Ratio - Example 1
From CFI’s Balance Sheet Template

 

Operating Cash to Debt Ratio - Example 2
From CFI’s Cash Flow Statement Template

 

The red boxes highlight the important information that we will need to calculate Operating Cash to Debt, namely short term debt long term debt and cash flow from operations. Using the formula provided above, we arrive at the following figures:

 

Operating Cash to Debt Ratio - Example 3

 

Here, we see that Bill’s OC to Debt Ratio hovers around the 10% mark. This means that should Bill’s choose to dedicate all of its cash earned from operating activities repaying its debt, it would be able to pay off 10% of its debt. While it is likely not wise to utilize cash in such a way, the measure does provide some context as to where the business stands with regards to its debt repayment ability and cash situation.

To better understand the financial health of the business, the Operating Cash to Debt ratio should be computed for a number of companies that operate in the same industry and compared. If some other firms operating in this industry see OC-Debt percentages that are, on average, lower than Bill’s, we can conclude that Bill’s is doing a relatively good job of managing its degree of financial leverage. In turn, creditors may be more likely to lend more money to Bill’s if the company represents a fairly safe investment within the baguette industry.

 

Additional Resources

Thank you for reading this article! CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To learn more about related topics, check out the following resources:

  • How to Calculate Debt Service Coverage Ratio
  • Current Portion of Long-Term Debt
  • Accounting Fundamentals Course – CFI
  • Defensive Interval Ratio

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