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The current cash debt coverage ratio is one example of a cash-basis ratio. Essentially, the ratio provides a means of identifying the current rate of cash flow while making allowances for the shift in liabilities from one portion of the period to the next.
Evaluating the cash flows and their sources, along with calculating the average current liabilities for the period cited, helps to identify any potential problems in the flow of operating capital before the issue has a chance to escalate.
Part of the beauty of a current cash debt coverage ratio is that it takes very little to calculate the figure as it applies to a given time period. The formula involves identifying the net cash that has been generated by various operating activities and dividing the net cash by the average current liabilities as they stand for the same time frame. The resulting figure can tell a great deal about the overall financial health of the company, and how the current status compares to the debt coverage ratios for previous periods.
The main function of this ratio is to understand the current status of liquidity within the company. Unlike some of the other calculations of ratios used in other accounting formulas, the current cash debt coverage ratio does not take into account any type of year ending balance. The focus is on a specific time period, usually most recently completed period, such as a month or a quarter. The same basic formula can also be applied to the current incomplete period, although this is uncommon.
Calculating the ratio is a simple way to check on the stability of cash flow versus production and other costs as they currently stand. When there appears to be a drop in the ratio in comparison to previous periods, this can serve as a signal that something is amiss. It is then possible to examine all relevant factors since the beginning of the period under consideration and determine what is changed, how severe the change happens to be, and take steps to correct the situation if that action is advisable. From this perspective, it can be very important to the ongoing life and health of a business.
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