Cash Coverage Ratio

Cash coverage ratio can be defined as the amount of cash available in hand in order to pay the interest expense of the business. This ratio shows the amount of cash in hand that will be paid for the interest expense of the borrower. This is depicted in the form of ratio between cash and interest and must be greater than 1:1 in order to fulfill entire interest expense. In order to calculate the cash coverage ratio we need EBIT that is earnings before taxes and interest. This figure is taken from the income statement of the business. Along with the EBIT the non cash expense such as depreciation and amortization expense are added to EBIT. The sum EBIT and non cash expenses are then divided with the interest expense of the business to get cash coverage ratio. The formula of cash coverage ratio can be shown as under:-

Cash Coverage Ratio = Earnings before taxes and interest + non cash expense/ Interest Expense

Example of Cash Coverage Ratio can be shown as under:-

Suppose ABC company has taken debt to payout its leverage obligations. The company wants to make sure that it has enough cash in hand to pay the interest expense on the acquired debt. The earnings before taxes and interest generated by the company is $1,200,000. The depreciation recorded by the company for that accounting period is $80,000. The interest needed to pay by the company in the coming year is $1,500,000. The cash coverage ratio can be calculated as under:-

Cash Coverage Ratio = EBIT +non cash expense/interest expense

= 1,200,000 + 800,000/ 1,500,000

= 1.33 Cash Coverage Ratio


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