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FFO-to-Debt Ratio

The FFO-to-debt ratio is a measure of a company’s ability to pay off debts using only income from its business. Money from operations includes money that the company collects in the current year from the inventory the company sells and the services the company provides to customers, and this entry is the same at every rate. Because a company can compare its operating income with different types of debt, some FFO-to-debt ratio is possible.

FFO to Debt Ratios
FFO to Debt Ratios

Risk

FFO ratios to debt are prudent because they do not include other sources of cash that the company can use, such as income from equipment sales or bond issuance. If the FFO ratio to short-term debt is less than 1, the company has immediate difficulties and must sell production equipment or borrow another loan. An FFO-to-total debt ratio (or long-term debt) of less than 1 can be accepted if the company expects to increase sales revenue without increasing total debt in the coming years.

Non-cash costs

Non-cash costs are part of the FFO-to-debt ratio, according to Standard & Poor’s. Some costs, such as vehicle depreciation and production equipment, may be directly related to operations. A company may also depreciate certain expenses, such as the fee they have to pay to have the right to use another company’s patent for a period of 10 years. Tax debt reduces the source of money from operations instead of increasing debt.

Capital projects

The FFO-to-debt ratio does not include bills for capital projects, according to Fitch Ratings. A capital project is a project that a company undertakes to increase the number of products it can produce in the future instead of maintaining its current production capacity, so the cost of the capital project does not reduce the company’s operating capital. The free cash flow-to-debt ratio, including capital expenditures, will be lower than the FFO-to-debt ratio.

Comparison of gross margins

FFO is similar to gross margin, except it is a measure of cash flow instead of a balance sheet measure. Gross profit margin includes all revenue that the company is entitled to receive, so it includes non-cash asset accounts such as receivables. FFO includes the amount of money a company collects in one year from sales made in the previous year, but it does not include sales that the company makes in the current year if the customer will pay the invoice the following year.

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