Cash Flow Adequacy Ratio – Definition and Formula

Investors and analysts can use the cash flow adequacy ratio to gauge a company’s financial health and determine its capacity to generate cash and handle its financial obligations. It is typically used in conjunction with other financial ratios and metrics to get a more complete picture of the company’s financial health.

What is the cash flow adequacy ratio?

The cash flow adequacy ratio is a financial measure that compares a company’s cash inflows to its cash outflows. It is used to determine whether a company has sufficient cash to meet its short-term financial obligations and pay its bills.

Divide the company’s net cash inflow (cash inflows minus cash outflows) by its average monthly expenses (which include debt, capital expenditures (Capex), and dividends to shareholders) to determine the cash flow sufficiency ratio. A ratio of 1 or above shows that the business has enough cash on hand to cover its expenses, while a ratio of less than 1 suggests that the business may struggle to pay its debts.

Cash flow adequacy ratio formula

Cash Flow Adequacy Ratio = (Cash Flow from Operations / Capital Expenditures + Total Debt + Dividends) x 100%

Here, cash flow from operations refers to the cash generated from a company’s normal business operations. Capital expenditure (CAPEX) refers to the purchase of fixed assets. The total debt refers to the total amount of debt that the company has incurred. Dividends mean the issuance of cash to equity shareholders.

To calculate the ratio, you will need to first determine the cash flow from operations. This can be found on the company’s income statement under the “cash flow from operations” section. Next, you will need to determine the total debt of the company. This can be found on the company’s balance sheet under the “liabilities” section. Similarly, obtain the values of capital expenditure and dividends.

Once you have these two figures, you can plug them into the formula above to calculate the ratio. This ratio is expressed as a percentage, and a higher percentage indicates that the company has a stronger ability to pay off its debt obligations using its cash flow from operations.


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