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Understand the cash coverage ratio, its formula, significance, and how to calculate it to evaluate a company’s ability to meet its interest obligations.
The cash coverage ratio is a financial metric used to determine how effectively a company can cover its interest expenses using the cash generated from operations. It measures liquidity strength and financial stability, providing insight into whether the business generates enough cash flow to service its debt comfortably.
The cash coverage ratio (CCR) evaluates a company’s ability to pay interest expenses from its available operating cash. It is particularly useful for lenders, investors, and analysts assessing a company’s debt-servicing capability.
A higher CCR implies that the company earns sufficient cash to meet its interest obligations, indicating strong financial health. Conversely, a lower CCR may suggest potential liquidity stress or over-leverage.
This ratio builds on the concept of the interest coverage ratio but focuses specifically on cash rather than accounting profits.
While profits can include non-cash items such as depreciation or amortisation, the cash coverage ratio isolates the actual cash inflows from operations. It therefore presents a more accurate picture of whether the firm can sustain its interest payments through real cash generation.
The formula for calculating the cash coverage ratio is straightforward:
Cash Coverage Ratio = (Cash Flow from Operations + Interest Paid) ÷ Interest Paid
| Component | Description |
|---|---|
Cash Flow from Operations (CFO) |
Cash generated from core business activities |
Interest Paid |
Total interest expense incurred during the period |
A ratio greater than 1 indicates that the company’s cash flow comfortably covers its interest costs.
Example:
If a firm’s operating cash flow is ₹12,00,000 and its annual interest expense is ₹3,00,000:
Cash Coverage Ratio = (₹12,00,000 + ₹3,00,000) ÷ ₹3,00,000 = 5.0
This means the company earns five times the cash required to pay its interest charges which is considered to be a strong sign of financial stability.
To calculate CCR accurately, follow these steps:
Obtain the Cash Flow from Operations (CFO) from the cash flow statement.
Add back interest paid, as it is typically shown under financing activities.
Divide the total by interest paid to find the ratio.
This process helps assess the efficiency of cash generation in meeting interest liabilities without relying on accounting-based measures such as EBIT.
The CCR is an important indicator of financial resilience, especially for firms with debt obligations.
It helps:
Lenders determine the borrower’s repayment capacity.
Investors evaluate a company’s risk profile before investing in debt or equity.
Management assess liquidity strength and optimise debt structure.
A consistently high ratio signifies sound liquidity management and lower financial risk.
The cash coverage ratio offers multiple benefits:
Provides a realistic measure of debt-paying capacity.
Excludes non-cash accounting adjustments for greater accuracy.
Enables comparison across time periods to track liquidity trends.
Serves as a reliable benchmark for credit analysis and loan approvals.
By highlighting how much cash is available relative to interest obligations, it supports informed financial decisions.
While insightful, the ratio has certain limitations:
It ignores principal repayments, which can be significant.
Cash flows may fluctuate seasonally, distorting short-term analysis.
Differences in accounting standards can affect comparability.
A high ratio does not always imply overall profitability.
Thus, it should be assessed alongside other financial ratios for a holistic view of liquidity.
Both ratios measure liquidity but focus on different aspects of financial health.
| Basis | Cash Coverage Ratio (CCR) | Current Ratio |
|---|---|---|
Focus |
Cash flow-based debt coverage |
Short-term asset coverage |
Formula |
(CFO + Interest Paid) ÷ Interest Paid |
Current Assets ÷ Current Liabilities |
Purpose |
Evaluates ability to pay interest from cash flow |
Evaluates liquidity position using balance sheet items |
Relevance |
Preferred for debt-heavy firms |
Useful for working capital management |
Together, they provide complementary insights into a company’s liquidity and solvency.
The cash coverage ratio is an essential tool for understanding a company’s ability to service its debt from operational cash flows. A ratio significantly above 1 indicates strong financial stability, while a lower figure may warrant closer monitoring.
When used in conjunction with other financial indicators, CCR offers a well-rounded picture of a company’s liquidity and creditworthiness.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
The cash coverage ratio measures how effectively a company can pay its interest obligations using the cash flow generated from operations, indicating its short-term liquidity strength.
It is calculated using the formula (Cash Flow from Operations + Interest Paid) ÷ Interest Paid. The result shows how many times a company’s cash flow covers its interest expense.
The ratio helps lenders assess a borrower’s repayment capacity, ensuring that the company has sufficient operating cash to meet its debt obligations on time.
While the cash coverage ratio focuses on debt coverage using cash flows, the current ratio assesses liquidity based on balance sheet items such as current assets and liabilities.
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