Operating Cash to Debt Ratio

The operating cash to debt ratio, as the name implies, compares the company’s overall cash flow to its total debt. This is a form of coverage ratio that may be used to estimate how long it would take a company to pay off its debt if it utilized all of its cash flow. The operating cash flow refers to the money that an organization creates through its center working exercises. This usually refers to the most significant source of revenue for a company.

Instead of earnings, cash flow is employed since it is a more accurate indicator of a company’s financial ability. The operational cash to debt ratio can be used to determine the likelihood of a corporation failing on interest payments. In any case, the proportion offers a brief look into an organization’s overall monetary position. A high proportion shows a business that is exceptionally fit for reimbursing its obligation and assuming more obligation if necessary. When a firm generates a large amount of cash in comparison to its debt, it implies that it is well-positioned to repay its loans. Creditors consider it a safer debt investment as a result.

Example of Operating Cash to Debt Ratio

EBITDA is a poor indicator of a company’s strength; cash flow from operations is a better indicator (Earnings before Interest, Tax, Depreciation, and Amortization). Determine the annual operational cash flow, which is one of the three cash flows given on the cash flow statement, to compute a company’s cash flow-to-debt ratio. A high proportion shows an organization probably has a lower likelihood of defaulting on its advances, making it a more secure speculation opportunity for obligation suppliers. Alternately, a low proportion demonstrates the organization has a higher possibility of defaulting, as it has less money accessible to commit to obligation reimbursement.

The formula of Operating Cash to Debt ratio is

OC-Debt Ratio = Cash Flow from Operations / Total Debt


  • Cash Flow from Operations – refers to the cash flow generated by the business as a result of its operations. On a company’s cash flow statement, this number can be found.
  • Total Debt – refers to the total debt that a company has. This is calculated by aggregating the company’s short- and long-term debt. Both of these values can be seen on the balance sheet of the company.

Generally, this ratio is communicated as a rate. In any case, if an organization needs to show the quantity of years it would take to take care of all its obligations, then, at that point one can introduce similar ratio in years too. It shows how long it would take a company to pay off all of its debt if all of its operating cash flow was dedicated to debt reduction (although this is a very unrealistic scenario). A high OC to Debt ratio, in general, suggests that a company is highly mature, as it generates a lot of cash from operations.

While it is ridiculous for an organization to dedicate the entirety of its income from activities to obligation reimbursement, the income to-obligation proportion gives a depiction of the in general monetary strength of an organization. Obligation suppliers commonly really like to loan cash to organizations with a high OC to Debt proportion. As previously said, such businesses generate consistent cash flows from operations and are unlikely to be over-leveraged. A ratio of one or more is ideal, however one or less implies that a company isn’t generating enough cash flow and lacks the liquidity to pay its debt obligations.

Absolute obligation computation considers interest and head installments from current budget summaries. All things considered, organizations can utilize a wide range of financing plans, for example, making interest-just installments, negative amortization, shot installments and the remainder. Instead of cash flow from operations, another technique to determine the cash flow-to-debt ratio is to look at a company’s EBITDA. This approach is utilized less frequently since it requires an investment in inventory, which is not as liquid as cash from operations because inventory may not be sold immediately.

In such cases, the organization may pay changing measures of interest starting with one year then onto the next, which basically implies that present-year numbers may not generally reflect future figures. A few experts utilize free income rather than income from activities since this action takes away money utilized for capital uses. The Operating Cash to Debt ratio should be compared to the data for a number of companies in the same industry to have a better understanding of the financial health of the company. As a result, using free cash flow rather than cash flow from operations may signal that the corporation is less able to satisfy its obligations.

Additionally, in ascertaining the income to obligation proportion, examiners don’t typically consider income from financing or from contributing. Investigators once in a while likewise inspect the proportion of income to simply long-haul obligation. If a corporation has taken on large short-term debt, this ratio may paint a more flattering image of its financial health. As a result, EBITDA does not provide a realistic picture of how much cash the company has available to pay off its debts.

Free income is taken subsequent to deducting cash utilized for capital uses. Utilizing free income will influence the proportion and show the organization as being less fit for overhauling its obligation. A business with an exceptionally utilized capital construction will likely have a significant measure of obligation to cover. It is unreasonable to suppose that the corporation is using its loan capital to pay off its debt. As a result, financing cash flow is not included in the calculation.

Another factor omitted by the operating cash flow method is cash flow from investments, which isn’t considered a core cash-generating activity. Analysts believe it is better to use a cash flow value that more accurately reflects the daily operations of the business, such as cash flow from operations. Because the ratio may be derived using non-standard variables and does not account for other industry-specific aspects that influence the resultant figure, it should be considered alongside other financial statements and in the context of comparable companies.

The outcome could likewise contrast if an expert picked either the long haul or transient obligation to ascertain the proportion. The proportion would give better outcomes if the experts select momentary obligation, yet the organization has all the more long-haul obligation on its asset report, and the other way around. Another prominent application of the cash flow to debt ratio is in the evaluation of a company’s past debt repayment performance. Although this may not be a reliable indicator of future performance, analysts can tweak the ratio to make it more useful.

Information Sources:

  1. studyfinance.com
  2. efinancemanagement.com
  3. corporatefinanceinstitute.com
  4. thebalance.com
  5. investopedia.com