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A financial indicator, the cash coverage ratio, assesses a company's capacity to settle its short-term debt commitments entirely from cash and cash equivalents. It is a crucial indicator of a company's financial stability and solvency since it shows if it has enough cash on hand to cover its immediate financial obligations.
This ratio represents the real dollar quantities held in marketable securities that can be instantly converted into cash as well as in a company's bank accounts. The ratio then evaluates these sums about the business's current liabilities.
This liquidity ratio provides a far more cautious evaluation of how well a company is now positioned to service its short-term debt load than other coverage ratio computations like the quick ratio or the current ratio since it excludes assets like inventories and customer receivables.
This ratio may provide you with the most accurate view of a company's liquidity situation because receivables might take weeks or months to collect and inventory can take years to sell.
The cash coverage ratio is calculated using the following formula:
Cash Coverage Ratio = (Cash + Cash Equivalents) / Current Liabilities
The quantity of cash and cash equivalents that a company has on hand can be found on its balance sheet. Any short-term investments that may be converted into cash in three months or less will be considered cash equivalents.
A cash ratio of 1 or greater generally indicates a favorable scenario and indicates that the company you are evaluating can pay its current debts entirely out of available cash. When the ratio is less than 1, the company would have to use other short-term assets, like its receivables, to cover all of its current obligations.
This liquidity ratio provides a far more cautious evaluation of how well a company is now positioned to service its short-term debt load than other coverage ratio computations like the quick ratio or the current ratio since it excludes assets like inventories and customer receivables.
This ratio may provide you with the most accurate view of a company's liquidity situation because receivables might take weeks or months to collect and inventory can take years to sell.
Formula
The company's cash and cash equivalents are split by its short-term loan obligations to determine the cash coverage ratio. The ratio that results demonstrates how many times the company's cash and cash equivalents can pay down its current liabilities. A smaller ratio could signify financial duress and the possibility of default, whereas a greater ratio shows a stronger financial condition.The cash coverage ratio is calculated using the following formula:
Cash Coverage Ratio = (Cash + Cash Equivalents) / Current Liabilities
The quantity of cash and cash equivalents that a company has on hand can be found on its balance sheet. Any short-term investments that may be converted into cash in three months or less will be considered cash equivalents.
Understanding Cash Coverage Ratio
The easiest way to examine this ratio—which demonstrates how easily a business may pay off its current commitments with just cash and equivalents—is in combination with other debt coverage ratios and other liquidity ratios in particular.A cash ratio of 1 or greater generally indicates a favorable scenario and indicates that the company you are evaluating can pay its current debts entirely out of available cash. When the ratio is less than 1, the company would have to use other short-term assets, like its receivables, to cover all of its current obligations.
