What Is Funds From Operations (FFO) to Total Debt Ratio?
The funds from operations (FFO) to total debt ratio is a leverage ratio that a credit rating agency or an investor can use to evaluate a company’s financial risk. The ratio is a metric comparing earnings from net operating income plus depreciation, amortization, deferred income taxes, and other noncash items to long-term debt plus current maturities, commercial paper, and other short-term loans. Costs of current capital projects are not included in total debt for this ratio.
Formula and Calculation of Funds From Operations (FFO) to Total Debt Ratio
FFO to total debt is calculated as:
Free cash flow / Total debt
Where:
- Free cash flow is net operating income plus depreciation, amortization, deferred income taxes, and other noncash items.
- Total debt is all long-term debt plus current maturities, commercial paper, and short-term loans.
Key Takeaways
- Funds from operations (FFO) to total debt is a leverage ratio that is used to assess the risk of a company, real estate investment trusts (REITs) in particular.
- The FFO to total debt ratio measures the ability of a company to pay off its debt using net operating income alone.
- The lower the FFO to total debt ratio the more leveraged the company is, where a ratio below one indicates the company may have to sell some of its assets or take out additional loans to stay in business.
What Funds From Operations (FFO) To Total Debt Ratio Can Tell You
Funds from operations (FFO) is the measure of cash flow generated by a real estate investment trust (REIT). The funds include money the company collects from its inventory sales and services it provides to its customers. Generally Accepted Accounting Principles (GAAP) require REITs to depreciate their investment properties over time using one of the standard depreciation methods, which can distort the true performance of the REIT. This is because many investment properties increase in value over time, making depreciation inaccurate in describing the value of a REIT. Depreciation and amortization must, thus, be added back to net income to reconcile this issue.
The FFO to total debt ratio measures the ability of a company to pay off its debt using net operating income alone. The lower the FFO to total debt ratio, the more leveraged the company is. A ratio lower than 1 indicates the company may have to sell some of its assets or take out additional loans to keep afloat. The higher the FFO to total debt ratio, the stronger the position the company is in to pay its debts from its operating income, and the lower the company's credit risk.
Since debt-financed assets generally have useful lives greater than a year, the FFO to total debt measure is not meant to gauge whether a company's annual FFO covers debt fully, i.e. a ratio of 1, but rather, whether it has the capacity to service debt within a prudent timeframe. For example, a ratio of 0.4 implies the ability to service debt fully in 2.5 years. Companies may have resources other than funds from operations for repaying debts; they might take out an additional loan, sell assets, issue new bonds, or issue new stock.
For corporations, the credit agency Standard & Poor’s considers a company with an FFO to total debt ratio of more than 0.6 to have minimal risk. A company with modest risk has a ratio of 0.45 to 0.6; one with intermediate-risk has a ratio of 0.3 to 0.45; one with significant risk has a ratio of 0.20 to 0.30; one with aggressive risk has a ratio of 0.12 to 0.20; and one with high risk has an FFO to total debt ratio below 0.12. However, these standards vary by industry. For example, an industrial (manufacturing, service, or transportation) company might need an FFO to total debt ratio of 0.80 to earn an AAA rating, the highest credit rating.
Limitations of Using FFO to Total Debt Ratio
FFO to total debt alone does not provide enough information to decide a company’s financial standing. Other related, key leverage ratios for evaluating a company’s financial risk include the debt to EBITDA ratio, which tells investors how many years it would take the company to repay its debts, and the debt to total capital ratio, which tells investors how a company is financing its operations.
FAQs
The FFO to total debt ratio measures the ability of a company to pay off its debt using net operating income alone. The lower the FFO to total debt ratio, the more leveraged the company is. A ratio lower than 1 indicates the company may have to sell some of its assets or take out additional loans to keep afloat.
How do you calculate FFO funds from operations? ›
FFO is calculated by adding depreciation, amortization, and losses on sales of assets to earnings and then subtracting any gains on sales of assets and any interest income. It is sometimes quoted on a per-share basis.
What is a good cash from operations to total debt ratio? ›
However, a healthy ratio would generally fall between 1.0 and 2.0, with anything above 2.0 being considered very strong. This indicates that the company has more than enough operational cash flow to cover its total debt.
What is the OCF to debt ratio? ›
What is the Operating Cash to Debt Ratio? The Operating Cash to Debt Ratio measures the percentage of a company's total debt that is covered by its operating cash flow for a given accounting period. The operating cash flow refers to the cash that a company generates through its core operating activities.
What is the FFO debt rating? ›
FFO as a determiner of creditworthiness: FFO is an important metric used by credit rating agencies to assess a company's ability to generate cash flow and meet its debt obligations. A higher FFO indicates a company's ability to generate sufficient cash flow to cover its interest expenses and repay its debt.
What is the funds from operations FFO to total debt ratio? ›
Funds from operations (FFO) to total debt is a leverage ratio that is used to assess the risk of a company, real estate investment trusts (REITs) in particular. The FFO to total debt ratio measures the ability of a company to pay off its debt using net operating income alone.
What is a good FFO ratio? ›
REITs tend to have higher-than-average payout ratios, and 70–80% of FFO is common. But if this percentage is too close to (or higher than) 100%, a dividend cut could be on the horizon.
What is a bad cash to debt ratio? ›
By calculating the ratio between your income and your debts, you get your “debt ratio.” This is something the banks are very interested in. A debt ratio below 30% is excellent. Above 40% is critical. Lenders could deny you a loan.
What is the most useful debt ratio? ›
In general, many investors look for a company to have a debt ratio between 0.3 and 0.6. From a pure risk perspective, debt ratios of 0.4 or lower are considered better, while a debt ratio of 0.6 or higher makes it more difficult to borrow money.
What is a bad debt to worth ratio? ›
Lenders prefer bad debt to sales ratios under 0.4 or 40%. However, most companies prefer to have much lower numbers than this. Unless you have no bad debt, there is room to improve.
A ratio less than 1 indicates short-term cash flow problems; a ratio greater than 1 indicates good financial health, as it indicates cash flow more than sufficient to meet short-term financial obligations.
What should debt to ratio be? ›
Read our editorial guidelines here . Your debt-to-income (DTI) ratio is how much money you earn versus what you spend. It's calculated by dividing your monthly debts by your gross monthly income. Generally, it's a good idea to keep your DTI ratio below 43%, though 35% or less is considered “good.”
How to improve operating cash flow total debt? ›
Ways to increase cash flow for a business include offering discounts for early payments, leasing not buying, improving inventory, conducting consumer credit checks, and using high-interest savings accounts.
Why is the FFO important? ›
FFO is an important metric for providing investors with a more accurate reflection of a company's recurring income. It gives them more insight into a company's ability to pay and maintain its dividend.
What is a healthy debt load? ›
Ideally, financial experts like to see a DTI of no more than 15 to 20 percent of your net income. For example, a family with a $250 car payment and $100 of monthly credit card payments, and $2,500 net income per month would have a DTI of 14 percent ($350/$2,500 = 0.14 or 14%).
What is a safe debt load? ›
A debt/income ratio of 10 percent or less means that your finances are exceptionally healthy, and ratios within a range of 10 to 20 percent represent good credit, but at 20 percent or above, it's time to assess your debt load.
Is FFO the same as operating income? ›
Net Operating Income (NOI) → While funds from operations (FFO) provide a levered measure of profit after taxes and overhead, net operating income (NOI) provides a pure, property-level measure of profit.
What is the formula for adjusted funds from operations? ›
Though no one official measure exists, an AFFO formula is along the lines of AFFO = FFO + rent increases - capital expenditures - routine maintenance amounts.
What is price to funds from operations ratio? ›
P/FFO measures the ratio of the share price to the mean cash flow from operations. A high ratio suggests that the stock is priced higher compared to the company's cash flow - a sign of high investor confidence. Nevertheless, a high ratio also suggests that a stock may be overpriced.
