Total Debt to Free Cash Flow
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What is Total Debt to Free Cash Flow?
Total Debt to Free Cash Flow measures total debt relative to Free Cash Flow (FCF), assessing a company’s ability to repay debt from its cash flow generation.
How do you interpret Total Debt to Free Cash Flow?
Total Debt to Free Cash Flow compares total debt to Free Cash Flow (FCF), assessing the company’s ability to repay debt from its cash flow generation.
How to Calculate Total Debt to Free Cash Flow?
The ratio is calculated by dividing the company's total debt by its free cash flow (FCF).
Total Debt to Free Cash Flow = Total Debt / Free Cash Flow
where
- Total Debt: The sum of all short-term and long-term debt.
- Free Cash Flow (FCF): The cash generated from operations after capital expenditures and before dividends.
Why is Total Debt to Free Cash Flow important?
It is important because it indicates a company's ability to service its debt using cash generated from its operations. Investors and creditors use this ratio to gauge how effectively a company manages its debt obligations relative to its cash flow generation capabilities.
How does Total Debt to Free Cash Flow benefit investors?
Investors use this ratio to evaluate the financial health of a company, particularly its ability to meet debt obligations without affecting its operations. A company with a lower ratio is considered less risky from a debt management perspective.
Using Total Debt to Free Cash Flow to Evaluate Stock Performance
A lower Total Debt to Free Cash Flow ratio may indicate a financially stable company with lower risk, which could translate to stronger stock performance in the long term. Conversely, companies with high ratios might be riskier, especially if their free cash flow generation is weak.
FAQ about Total Debt to Free Cash Flow
What is a Good Total Debt to Free Cash Flow?
A good ratio depends on the industry, but generally, a ratio below 3x is considered strong, indicating that the company can pay off its debt within three years of free cash flow. Higher ratios can signal higher financial risk.
What Is the Difference Between Metric 1 and Metric 2?
While Total Debt to Free Cash Flow considers the actual cash available after operating expenses and capital expenditures, Debt to EBITDA focuses on a company’s earnings before interest, taxes, depreciation, and amortization. Free cash flow is often seen as a more conservative measure.
Is it bad to have a negative Total Debt to Free Cash Flow?
A negative ratio means the company is generating negative free cash flow, which can be a serious red flag for investors as it implies the company cannot cover its capital needs and debt obligations with its current operations.
What Causes Total Debt to Free Cash Flow to Increase?
The ratio increases if the company’s debt grows or its free cash flow declines. This could happen due to increased borrowing, higher capital expenditures, or reduced operating cash flow.
What are the Limitations of Total Debt to Free Cash Flow?
It does not account for the timing of debt repayments or interest obligations. It also doesn’t differentiate between types of debt (e.g., short-term vs. long-term debt), and free cash flow can fluctuate significantly based on capital expenditure requirements.
When should I not use Total Debt to Free Cash Flow?
This ratio may not be relevant for companies in industries with volatile cash flows or those that are highly capital-intensive, where large swings in free cash flow are normal.
How does Total Debt to Free Cash Flow compare across industries?
Capital-intensive industries, such as manufacturing or utilities, tend to have higher ratios because they require significant reinvestment in physical assets, reducing free cash flow. Conversely, service-based industries or tech companies might have lower ratios due to lower capital expenditure needs.
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