Ratio Analysis: Cash Sufficiency Ratio
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:
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Ratios For Cash Sufficiency |
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(a) Cash flow adequacy: |
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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 |
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(b) Long-term debt repayment |
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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 |
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(c ) Dividend payment |
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Purpose: to measure the entity’s ability to cover its dividend payments. Formula: Dividends paid Cash from operations |
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(d) Reinvestment |
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Purpose: to measure the entity’s ability to pay for its non-current assets out of cash from operations Formula: Non-current asset payments Cash from operations |
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(e) Debt Coverage |
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Purpose: to measure the payback period for coverage of long-term debt. Formula: Total long-term debt Cash from operations |
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