Total Cash-flow Coverage Ratio
However, coverage ratios mentioned above, suffer from one major limitation, that is, they relate the firm’s ability to meet its various financial obligations to its earnings. In fad, these payments are met out of cash available with the firm, Accordingly, it would be more appropriate to relate cash resources of a firm to its various fixed financial obligations. The ratio, so determined, is referred to as total cash flow coverage ratio. Symbolically,
The overall ability of a firm to service outside liabilities is truly reflected in the total cash flow coverage ratio: the higher the coverage, the better is the ability.
Internally generated cash from operating activities (CFO) are required for investment as well as debt servicing. A typical firm requires funds both for growth, apart from replacement of existing fixed assets (in particular, plant and machinery) and servicing of debt. Accordingly, a firm’a long-term solvency is a function of its ability (i) to finance the expansion and replacements needs of the business and (ii) to generate cash for servicing of debt.