A financial ratio that examines the adequacy of the cash left, after payment of interest, taxes and capital expenditures (CAPEX), to cover a company’s obligations. The following formula illustrates that:
The denominator refers to average annual debt maturities scheduled over the next five years. This ratio reflects credit quality, i.e., a company’s ability to meet its obligation on the mid run. For example, if a company has reported that its EBITDA, interest paid, taxes paid, CAPEX, and annual debt payment (of average annual debt maturities over the next five years) are $20,000, $2,000, $500, $40000, and $1,500, respectively. Then:
Cash flow adequacy ratio= (20,000-2,000-500-4,000)/1,500 = 9
This means the company is comfortably able to service its debt maturing within five years on average.
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