The cash coverage ratio is used to determine the amount of available cash for the payment of borrower’s interest expense. It is expressed as a ratio of the available cash to the amount of interest to be paid. The ratio must be substantially greater than 1:1 in order to show a sufficient ability to pay the interest expense.
Explanation of Cash Coverage Ratio
In other words, a cash coverage ratio is a measure of a company’s ability to pay the interest expense. It also helps companies in determining if the business is capable to make profit or spend its entire fund to pay down the debt. The formula of cash coverage ratio is based on 3 factors: earnings before interest and tax, non cash expense and interest expense. It is an indicator to show whether any business is able to meet its financial obligations. This formula is considered as accurate because it uses the actual cost and expense of the business for financial outcome.
In order to calculate cash coverage ratio, the formula is:
Earnings Before Interest and Taxes + Non-Cash Expenses