Ratio Analysis: Cash Sufficiency Ratio

October 2nd, 2006 Comments off
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The vein of an organization is the cash flow. In earlier article, we understand that cash flow statement is an integral part of the financial statements.

We can derive useful ratios the cash flow statement so as to assist us to evaluate the cash sufficiency of the entity.

When we say cash sufficiency of an entity, we basically mean the adequacy of the cash flows to meet the entity’s cash needs for long-term debt payments, dividends and acquisition of non-current assets.

However, we should not be confused with cash flow efficiency of the entity which is really the efficiency with which the entity generates cash from its revenues, profits and assets.

Let’s look at the ratios for Cash flow namely :

 

  • Cash Sufficiency and
  • Cash flow Efficiency:

 

Ratios For Cash Sufficiency

(a) Cash flow adequacy:

Purpose: to measure the entity’s ability to cover its main cash requirements

Formula:

Cash from operations

Long term debt paid + Assets Acquired + Dividends paid

(b) Long-term debt repayment

Purpose: to measure the entity’s ability to cover its long term debt out of cash from operations

Formula:

Long term debt repayments

Cash from operations

(c ) Dividend payment

Purpose: to measure the entity’s ability to cover its dividend payments.

Formula:

Dividends paid

Cash from operations

(d) Reinvestment

Purpose: to measure the entity’s ability to pay for its┬ánon-current assets out of cash from operations

Formula:

Non-current asset payments

Cash from operations

(e) Debt Coverage

Purpose: to measure the payback period for coverage of long-term debt.

Formula:

Total long-term debt

Cash from operations

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Financial Accounting

 
 

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