What is cash flow available for debt servicing (CFADS)?
Taking on debt is a key way to finance and grow a business, but you need to be able to pay it back, or you could face financial difficulties.
Cash flow available for debt servicing (CFADS) is a measurement used to calculate if your company has enough money available to service its debts.
Read our guide to how CFADS works and how it can benefit your business.
Cash flow available for debt servicing (CFADS), also known as cash available for debt service (CADS), measures how much cash a business has available to deal with its debt obligations once operating expenses, taxes, and capital expenditures have been deducted.
EBITDA (earnings before interest, taxes, depreciation, and amortisation) has been a standard measurement for the past 40 years, but CFADS is an increasingly popular alternative among businesses because it gives a more accurate picture of a company’s financial performance.
This is because, unlike EBITDA, CFADS takes into account taxes and other expenditure when assessing the cash flow of a business.
What is cash flow available for debt servicing (CFADS)?
CFADS is a useful calculation for measuring a business’s ability to service its debt.
It shows how efficiently a founder operates a business and uses debt to run and finance their operations.
CFADS is calculated once the following has been deducted:
- operating expenses – the costs involved in running your business, which include things like rent, business rates, staff salaries, sales and marketing, utility bills, office supplies, travel, and insurance
- taxes – the taxes you are paying to the government, such as corporation and income tax
- capital expenditures – the money you spend on purchasing and maintaining assets such as buildings, land, and equipment.
- working capital changes – how levels of working capital in areas such as accounts payable, accounts receivable, and inventory have changed over a given period.
The importance of CFADS
CFADS is critical for assessing a company’s ability to service its debt.
Banks, investors, and other financial providers often prefer it over EBITDA because it provides a more accurate measure of a business’s ability to meet its debt obligations.
CFADS vs. EBITDA
Understanding EBITDA
First used in the 1980s, EBITDA, which stands for earnings before interest, taxes, depreciation, and amortisation, is a standard measurement of a business’s profitability and financial performance.
- interest – the fee you’re charged when paying back your debt
- taxes – the amount you pay for taxes such as corporation tax and income tax
- depreciation – the decline in value over time of tangible (physical) assets such as machinery and vehicles
- amortisation – the eventual expiring of intangible (non-physical) assets, such as patents or copyright.
Banks and other financial providers commonly use EBITDA to compare two similar businesses and understand a company’s ability to generate cash flow.
Learn more about EBITDA with our guide.
Limitations of EBITDA
While EBITDA is a popular financial metric with several benefits, it has some limitations.
EBITDA calculations do not include key factors in a business’s financial health, such as capital expenditure, working capital changes, debt interest, taxes, depreciation, and amortisation.
Relying on that method can give a misleading picture of the company’s performance, profitability, cash flow health, and debt affordability.
Why CFADS is preferred
Funding providers often prefer CFADS because it gives a more accurate depiction of cash flow after accounting for necessary expenditures and debt obligations.
When a bank or other institution lends you money, it wants to know you can pay it back, so a strong CFADS ratio means you are more likely to secure the money you are asking for.
CFADS is particularly crucial in industries with high leverage such as property development, hospitality, and technology, where understanding the exact cash flow available for debt servicing can prevent financial distress.
Calculating CFADS
According to the Corporate Finance Institute, there are two common ways to calculate CFADS.
Starting with EBITDA
- adjust for changes in net working capital
- subtract spending on capital expenditures
- adjust for equity and debt funding
- subtract taxes.
Starting with receipts from customers
- subtract payments to suppliers and employees
- subtract royalties
- subtract the cash outflow related to capital expenditures during the period
- subtract taxes.
CFADS is subsequently divided by debt obligations, resulting in a ratio of a business’s cash flow to what is needed to pay the debt.
A ratio of below one means a business is unable to service its debt, one means the business has the exact amount needed to pay its debt, and above one means a business can fulfil its debt obligations with money left over.
Using CFADs in business planning
By incorporating CFADS into your business planning, you can make better decisions and build stronger relationships with financial lenders and investors.
There are various ways you can integrate CFADS into your financial planning.
When setting budgets and making financial forecasts, you can use CFADS to calculate more realistic financial targets and ensure you have enough funds to fulfil your aims.
By regularly tracking your CFADS, you can ensure you make more informed decisions.
CFADS is a key factor in building trust with lenders and investors.
By regularly reporting it to existing financial backers, you can ensure they remain confident and well-informed about your business.
It is also useful for getting new funding because a positive CFADS can help convince potential new investors or lenders to provide the funding you need.
If your business has shareholders, you can use CFADS to determine the level of dividends to pay them.
If you provide dividends that are too high, you may be unable to service your debts, which wouldn’t benefit anyone involved in the business.
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