What is Cash Flow Coverage Ratio (CFCR)?

The cash flow coverage ratio is an indicator of the ability of a company to pay interest and principal amounts when they become due. This ratio tells the number of times the financial obligations of a company are covered by its earnings. A ratio equal to one or more than one means that the company is in good financial health and it can meet its financial obligations through the cash generated by operating activities. A ratio of less than one is an indicator of bankruptcy of the company within two years if it fails to improve its financial position.

To calculate the cash coverage ratio, take the earnings before interest and taxes (EBIT) from the income statement, add back to it all non-cash expenses included in EBIT (such as depreciation and amortization), and divide by the interest expense. The formula is:

Earnings Before Interest and Taxes + Non-Cash Expenses
Interest Expense

Variations:A more conservative cash flow figure calculation in the numerator would use a company's free cash flow (operating cash flow minus the amount of cash used for capital expenditures).

A more conservative total debt figure would include, in addition to short-term borrowings, current portion of long-term debt, long-term debt, redeemable preferred stock and two-thirds of the principal of non-cancel-able operating leases.

What is Equity Multiplier?

Equity multiplier is a financial leverage ratio which is calculated by dividing total assets by the shareholders equity. It tells about assets in dollar per dollar of equity. The higher the ratio the lower the financial leverage and the lower the ratio the higher the financial leverage.

The formula for equity multiplier is total assets divided by stockholder's equity. Equity multiplier is a financial leverage ratio that evaluates a company's use of debt to purchase assets.

Equity multiplier is an important input in the DuPont return on equity analysis. DuPont return on equity analysis breaks up ROE into net profit margin, asset turnover and financial leverage (represented by equity multiplier as shown below:

ROE Under DuPont Analysis =	Net Income	×	Sales	×	Total Assets	=	Net Income
	Sales		Total Assets		Total Equity		Total Equity

The equity multiplier is a ratio used to analyze a company's debt and equity financing strategy. A higher ratio means that more assets were funding by debt than by equity. In other words, investors funded fewer assets than by creditors.

When a firm's assets are primarily funded by debt, the firm is considered to be highly leveraged and more risky for investors and creditors. This also means that current investors actually own less of the company assets than current creditors.

Lower multiplier ratios are always considered more conservative and more favorable than higher ratios because companies with lower ratios are less dependent on debt financing and don't have high debt servicing costs.

What is Asset Coverage Ratio?

Asset coverage ratio measures the ability of a company to cover its debt obligations with its assets. The ratio tells how much of the assets of a company will be required to cover its outstanding debts. The asset coverage ratio gives a snapshot of the financial position of a company by measuring its tangible and monetary assets against its financial obligations. This ratio allows the investors to reasonably predict the future earnings of the company and to asses the risk of insolvency.

Calculation (formula)

The asset coverage ratio is calculated in three steps:

• Step 1: The current liabilities are added up and short term debt obligations are subtracted from this sum.
• Step 2: The book value of tangible and monetary assets of a company is calculated by subtracting the value of intangible assets (such as goodwill) from the book value of total assets. The figure calculated in Step 1 is subtracted from this figure.
• Step 3: The resulting figure of Step 2 is divided by the total outstanding debt of the company.

All of these three steps can be expressed in the following formula for asset coverage ratio.

Asset Coverage Ratio = ((Total Assets – Intangible Assets) – (Current Liabilities – Short-term Debt)) / Total Debt Obligations

Usually a minimum level of asset coverage ratio is defined in the covenants so that a company does not overextend its debts beyond a certain limit. The company would not be tempted to take too much loans; therefore chances of its insolvency are less. As a rule of thumb, industrial and publicly held companies should maintain an asset coverage ratio of 2 and utilities companies should maintain an asset coverage ratio of 1.5.

When calculating the asset coverage ratio, investors should exercise caution with respect to asset value. Using the book value of assets may result in an inaccurate asset coverage ratio if the actual liquidation value of assets is significantly less. As a rule of thumb, utilities should have an asset coverage ratio of at least 1.5, and industrial companies should have a ratio of at least 2.