Require a cash outflow and thus more cash is

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require a cash outflow and, thus, more cash is available to "cover" fixed debt charges than - :-:L.-\P earnings would convey. Other versions of the ratio add back only amortization, or include interest expense in the denominator. See the module's Appendix for a list of ratios used by - gs agencies. The EBITDA coverage ratio is always higher than times interest earned (because - e depreciation add back) but measures the same concept: the companies' ability to pay inter- out of current profits. The graphic below compares Home Depot's times interest earned ratio EBITDA coverage. Home Depot Coverage Ratios 5.0 15.0 10.0 0.0 "'-- ~"__ ____L. __L. .... / from operations to total debt A company's liquidity depends critically on its ability to te additional cash to cover debt payments as they come due. The times interest earned and ITDA coverage ratios assume that the company needs to "cover" interest payments only each because the principal owing will be refinanced. This is not always a valid assumption. To e a company's ability to repay principal in the short and longer term, we can use the operat- ~ cash flow to total debt ratio. The ratio is defined as follows (related ratios exist that measure pany's ability to generate additional cash to short-term debt and long-term debt): Cash from operations Cash from operations to total debt = .... :c. _ Short-term debt + Long-term debt me year ended January 30,2011, Home Depot's statement of cash flows reported cash from tions of $4,585 million. Home Depot's cash from operations to total debt ratio was 0.47 in 1($4,585 million/[$1,042 million + $8,707 million]). This ratio hovers around 0.5 for Home t as the graphic on the next page shows. - ~ operating cash flow to total debt Companies must replace tangible assets each year to . ue operations. Any excess operating cash flow after cash spent on capital expenditures :\PEX) is considered "free" cash flow in that the company is free to use the cash for other ses including debt repayments. Some creditors use the following free cash flow measure as er coverage ratio. Cash from operations - CAPEX Free operating cash flow to total debt = -----~-------- Short-term debt + Long-term debt
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Home Depot Cash Flow Ratios 4-15 Module 4 I Credit Risk Analysis and Interpretation The free operating cash flow to total debt ratio is argued to reflect a company's ability to repay debt from the cash flows remaining after CAPEX. For the year ended January 30,2011, Home Depot's statement of cash flows reported cash spent for capital expenditures of $1,096 million. Thus, its free operating cash flow to total debt ratio is 0.36 in 2011 ([$4,585 million - $1,096 million)/[$1,042 million + $8,707 million]). This ratio was higher in 2011 and 2010 compared to the two prior years (see graphic below). This increase has two drivers: (1) Home Depot's CAPEX was much higher before the recession of 2008-09, and (2) the company had more debt in prior years.
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