Debt level and debt coverage
Debt level and debt coverage are important metrics to assess a company's financial performance and risk. They help to understand how easily a company can use its free cash flow or amount of cash to cover its annual interest and principal obligations. Free cash flow is the cash that a company generates from its operations after deducting capital expenditures. It represents the cash that a company can use for various purposes, such as paying dividends, buying back shares, or reducing debt.
A company's debt level is the total amount of debt that it owes to its creditors, such as banks, bondholders, or suppliers. Debt can be classified into short-term and long-term debt, depending on the maturity date of the obligations. Short-term debt is due within one year, while long-term debt is due after one year. Debt can also be classified into secured and unsecured debt, depending on whether the creditor has a claim on the company's assets in case of default. Secured debt is backed by collateral, such as property or equipment, while unsecured debt is not.
A company's debt coverage is the ratio of its free cash flow to its total debt service, which is the sum of interest and principal payments on its debt. Debt coverage measures how many times a company can pay off its debt obligations with its free cash flow. A higher debt coverage ratio indicates that a company has more free cash flow available to service its debt and thus has a lower risk of default. A lower debt coverage ratio indicates that a company has less free cash flow available to service its debt and thus has a higher risk of default.
Comparing debt to cash is another essential indicator to measure a company's ability to service debt with cash. Cash is the most liquid asset that a company has and can be used to pay off debt obligations quickly and easily. A high level of cash relative to debt indicates that a company has better financial health and a lower probability of defaulting on its loans. It also implies that a company has more financial flexibility and can take on more debt if necessary. A low level of cash relative to debt indicates that a company has worse financial health and a higher probability of defaulting on its loans. It also implies that a company has less financial flexibility and may face liquidity problems if it cannot generate enough cash from its operations or raise funds from external sources.
Debt level and debt coverage are not static measures and can change over time depending on a company's operating performance, investment decisions, financing activities, and market conditions. Therefore, it is important for investors and creditors to monitor these metrics regularly and compare them with industry benchmarks and historical trends to evaluate a company's financial position and risk profile.