Q: What can you tell me about the Funded Debt to EBITDA ratio, its calculation and its use?
A: The ratio is sometimes used as a cash flow covenant. Funded debt is long-term debt financed debt that comes due in a longer time period than a year. The ratio measures the company's ability to pay off its long-term funded debt. A high ratio shows it takes longer for the company to pay off the funded debt; a lower rate conversely shows the company may take on more funded debt.
A few comments:
1. "Cash flow" is not cash flow. EBITDA is a poor measure, in general, since it does not include interest expense, taxes, or distributions for non-Subchapter C corporations. Those cash outlays are unavoidable and may dramatically increase the number of years required to fully pay down all third party interest-bearing debt using an adjusted EBITDA.
2. The real value of this measure may be its change from year to year. If it's stable or declining, that's a positive sign that the debt service burden is stable or declining. If it's increasing, a negative sign that the debt service burden is increasing.
3. Whether a company can handle any debt service burden can only be identified by reference to the UCA cash flow statement.
In some respects, this risk measure is like a leverage ratio. Less is better than more. But to quantify what is acceptable is impossible based only on the ratio itself.
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