The cash flow-to-debt ratio is defined as the ratio of a company’s cash flow from operations to its total debt.
This factor is a type of coverage ratio that serves in determining how long would a company be able to repay its debt if it dedicated its entire cash flow to debt repayment.
Cash flow is a better measure than earnings as cash flow gives a better estimate of a company’s real potency to pay its outstanding obligations.
Significance and Calculations
The cash-to-credit ratio gives an overview of the overall financial health of a firm. A high ratio states that a company can conveniently pay back its debt, and can take on more debt if needed.
You can also calculate the cash-to-credit ratio by looking at a company’s EBITDA instead of the cash flow from operations.
This option involves investment in inventory which is why it is seldom used. Considering that inventory is slow to sell, it is not as liquid as cash from operations.
Tips For a Healthy Cash-To-Credit Ratio
For you to maintain a decent cash-to-credit ratio, you need to learn new ways to maintain its health and minimise credit adequately.
Here are enlisted 5 tips that can help you achieve the desired ratio for your company –
- Swift Invoice Submission
Submit your invoices as fast as you can to your customers.
The more your accounts receivables rise, and the quicker you receive cash for your sales, the higher your cash ratio can be, and you would never be short on cash.
Emphasise on ageing accounts and make sure the customers pay on time.
Pay off some of your liabilities swiftly, especially the minor ones with minimal money values. This way, you can gain your assets quickly and lose the debt owed even faster.
- Go for the Long-Term Debt
Try going for long-term debt to finance your business rather than the traditional short-term debt. Long-term debt renders the benefit of fewer monthly instalments and lesser interest rates.
Elimination of short-term debt from your balance sheet gives you a better Quick and Current ratios and helps save some of your liquidity in the near term so you can employ it in areas that matter.
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- Dispose Of Useless Assets
Every business houses unproductive assets. You need to scout for these redundant assets and sell them out. It is laying there, wasting resources and not earning anything.
You can try and get a reasonable price for it instead of letting it collect dust. Some assets are not worth anything in the market, and the best course of action is to get rid of them for whatever best price is offered to you.
Your cash balances are bound to rise after selling off redundant assets. You also don’t need to account for depreciation, and the ratios would drastically improve.
- Limit Your Overhead Expenditures
Your monthly expenditures on rent, labour, professional fees, and marketing are enormous, yet many of them are unnecessary.
Reduce these unnecessary expenditures and your short-term would plummet. Your overall cash-retention in business would also thrive.
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- Strive For Long-Lasting Payment Cycles
Some vendors have adopted the motto of being paid quickly, but everybody is not.
It would be best if you try to negotiate longer payment cycles with these vendors. Pursue them to give you discounts.
You can still own your money for long, and also pay a lower amount than what you owed initially.
- Review Profits
You must review the profitability of your different products and services.
Pull up some insights, assess where prices can be elevated regularly to keep the cash flow incoming.
As your costs would rise and markets would show volatility, prices might need some tweakings as well to be charged from your customers.
Final Words
It would be best if you kept an eye out for liquidity ratios as they would help your business thrive.
Since they deal with the short term, it can become harder to solve, and might require urgent measures to get back on track.
The lack of liquidity has claimed the healthy lives of many businesses.
Ensure that your business thrives on healthy cash flow, and possesses assets that can be liquidated conveniently.
A capable and intellectual Chief Financial Officer service provider can surely assist you in ensuring that you maintain a healthy cash-to-credit ratio and stay afloat in the competition.
