Compute current cash debt coverage ratio. Why is it computed?

Current cash debt coverage ratio is a liquidity ratio that measures the relationship between net cash provided by operating activities and the average current liabilities of the company. It indicates the ability of the business to pay its current liabilities from its operations.

Formula:

It is computed by the following formula:

current-cash-debt-coverage-ratio-formula

The two components of the formula are net cash provided by operating activities and average current liabilities. The net cash provided by operating activities is the net cash generated from its operations during a particular period. The average current liabilities are equal to opening liabilities plus closing liabilities divided by two.

Example:

Suppose a company generated $55,000 cash from operations during the last year. The current liabilities at the beginning and at the end of the year were $45,000 and $60,000 respectively. The current cash debt coverage ratio would be computed as follows:

$55,000 / $52,500*

1.05

or

1.05 : 1

*($45,000 + $60,000) / 2

Significance and interpretation:

A higher current cash debt coverage ratio indicates a better liquidity position. Generally a ratio of 1 : 1 is considered very comfortable because having a ratio of 1 : 1 means the business is able to pay all of its current liabilities from the cash flow of its own operations.