Current Cash Coverage Ratio Definition - Formula - Example - Interpretation - Importance
What is Current Cash Coverage Ratio:
There are many Debt Coverage Ratios and Current Cash Coverage Ratio is one of them. The Purpose of this Ratio is to measure the ability of the firm in meeting its Current Liabilities
of the Business Operations. This ratio is obtained by the relationship of Net Cash From Operating Activities divided by Average Liabilities in order to judge whether the business can sustain its current liabilities of the
business operations or not.
Formula:
Mathematically, we can write as:
Current Asset Debt Coverage Ratio = Net Cash From Operating Activities / Average Current Liabilities
Here:
Average Current Liabilities = Opening Current Liabilities + Closing Current Liabilities / 2
Example:
If a company has Net Cash From Operating Activities For The Period is Rs.700000, while Opening Liabilities are Rs. 500000 and Closing Liabilities are Rs. 300000, then we can find
the ratio as shown below:
700000 / 400000 = 1.75
Here Average Liabilities = 500000 + 300000 / 2 = 400000
As, Current Asset Debt Coverage Ratio is more than 1, so it is a good sign for the company to pay off its Current liabilities of the business operations.
Interpretation
If this ratio is greater, then it indicates that the firm can easily meet its operations by utilizing its net Cash in Future Accounting Period. If this ratio is 1:1, then it is to
be considered ideal but it all depends upon the particular type of industry in which the business is operating.
Importance / Significance
For Investors and Creditors, it is very important to find out the Current Asset Debt Coverage Ratio, as this ratio shows the company’s ability to pay off its current debts
of the business operations. The investors are interested in getting good returns for their investments while creditors are interested in receiving prompt payments for their Credits.
So, Current Asset Debt Coverage Ratio plays a key role in assessing the company’s strength in meeting its Current Liabilities of the Business Operations.
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