The cash flow leverage ratio -- also referred to as the cash flow coverage ratio or cash flow to debt ratio -- evaluates how much available cash from operations a business has relative to its outstanding debt. Creditors use this ratio to understand how much free cash a business has to make interest and principle payments on debt.

Why Cash Flow Leverage Matters

The cash flow leverage ratio is similar to the return on debt ratio. The primary difference is that the cash flow leverage ratio evaluates cash flows rather than net income. Because of the way accrual accounting works, a business can have a high amount of net income, but still be unable to pay its bills if it has trouble actually collecting cash from customers. Creditors often are more interested in net cash flows rather than net income because it's a better indicator of available resources.

Operating Cash Flows

One component of the cash flow leverage ratio is operating cash flows. A company can receive cash flows from operations, financing or investing activities. Much financial analysis focuses on cash flows from operations, because it represents cash flows from core business activities that the company can hopefully duplicate in future years. To calculate operational cash flow, add all cash received from operations -- generally, cash from sales of products and services -- and subtract operational cash outflows like payments to vendors, salaries, interest, rents, taxes, insurance and supplies. The difference is operating cash flow. For example, if cash receipts were $900,000 and cash payments were $400,000, the operating cash flow is $500,000.

Total Debt

The second component of cash flow leverage is total outstanding debt. For the purposes of this calculation, debt refers to financial liabilities that have a formal or written financing agreement. That means that total debt includes short-term and long-term borrowings such as notes, loans and bonds, but excludes other liabilities. For example, accounts payable, interest payable and deferred revenue would not be included in the calculation. To calculate total debt, add the outstanding balance in any note payable, bond payable and loan accounts on the balance sheet.

Determining and Analyzing the Ratio

To find a company's cash flow leverage, divide operating cash flow by total debt. For example, if operating cash flow is $500,000 and total debt is $1,000,000, the company has a cash flow leverage ratio of 0.5. The higher the ratio is, the better position the company is in to meet its financial obligations. If the ratio begins to decrease, that means cash flows are slowing down, the company has taken on more debt, or both. A declining ratio means the business may not have enough available cash to make its principle and interest payments on outstanding debt.