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We have looked at the articles:Profit Versus Cash & Accounting on Cash Basis Versus Accrual basis.We should able to understand that the vein of an organization is its cash flow. We also have reviewed the Cash Flow Statement which is an integral part of the financial statements and a very critical report to see how the company’s monies being utilized.
Here,this article showed that we can derive useful ratios from the cash flow statement to assist us to evaluate the cash sufficiency of the entity.
When we say cash sufficiency of an entity, we basically mean the adequacy of the cash flows to meet the entity’s cash needs for long-term debt payments, dividends and acquisition of non-current assets.
This should not be confused with cash flow efficiency of the entity which is really the efficiency with which the entity generates cash from its revenues, profits and assets.
Let’s look at the ratios for Cash flow namely :
- CASH SUFFICIENCY RATIO(PARTA) and
- Cash flow Efficiency(PartB)
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Ratios For Cash Sufficiency |
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(a) Cash flow adequacy: |
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Purpose: to measure the entity’s ability to cover its main cash requirements Formula: Cash from operations Long term debt paid + Assets Acquired + Dividends paid |
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(b) Long-term debt repayment |
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Purpose: to measure the entity’s ability to cover its long term debt out of cash from operations Formula: Long term debt repayments Cash from operations |
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(c ) Dividend payment |
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Purpose: to measure the entity’s ability to cover its dividend payments. Formula: Dividends paid Cash from operations |
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(d) Reinvestment |
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Purpose: to measure the entity’s ability to pay for its non-current assets out of cash from operations Formula: Non-current asset payments Cash from operations |
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(e) Debt Coverage |
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Purpose: to measure the payback period for coverage of long-term debt. Formula: Total long-term debt Cash from operations |
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