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
FFO-to-Debt = FFO / Total 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 the formula for the FFO ratio? ›
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 the funds from operations formula? ›
What is the FFO Formula? Here is the formula to calculate FFO: FFO = Net Income + (Depreciation expense + Amortization expense + Losses on sale of assets) – (Gains on sale of assets + Interest income)
How to calculate cash flow from operations to total debt ratio? ›
The cash flow-to-debt ratio is a comparison of a firm's operating cash flow to its total debt. You can calculate it by dividing the annual operating cash flow on the firm's cash flow statement by current and long-term debt on the balance sheet.
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.
Why do we use FFO? ›
Key Points. FFO measures cash generated by REITs from their core operations, excluding gains/losses on sales. It is used to assess the financial performance and value of real estate companies. FFO provides a more accurate depiction of a REIT's profitability than net income.
What is a good FFO payout ratio? ›
The payout ratio is derived by dividing the annual dividend by the EPS or FFO. Typically, a REIT with a payout ratio between 35% and 60% is considered ideal and safe from dividend cuts, while ratios between 60% and 75% are moderately safe, and payout ratios above 75% are considered unsafe.
What is a high price to FFO? ›
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.
How does S&P calculate FFO? ›
Our FFO metric indicates a company's ability to generate recurring cash flows from operations independent of changes in working capital. We derive our FFO metric from adjusted EBITDA and subtract cash interest and cash taxes.
FFO is a measure of cash flow and profitability, while NOI is a measure of how much money a property is making after all of its expenses have been paid. Both are considered important metrics by investors and analysts when evaluating the performance of a REIT or a property management company.
How do you calculate funds? ›
Net asset value (NAV) represents a fund's per-share intrinsic value. It is similar in some ways to the book value of a company. NAV is calculated by dividing the total value of all the cash and securities in a fund's portfolio, minus any liabilities, by the number of outstanding shares.
How do you calculate total profit from operations? ›
How Do You Find the Operating Profit Margin? The operating profit (or operating income) can be found on the income statement or calculated as: Revenue - Cost of Goods Sold - Operating Expenses - Depreciation - Amortization.
How to calculate total debt? ›
You collect all your long-term debts and add their balances together. You then collect all your short-term debts and add them together too. Finally, you add together the total long-term and short-term debts to get your total debt. So, the total debt formula is: Long-term debts + short-term debts.
What is the FFO to interest coverage ratio? ›
FFO-to-interest coverage ratio = FFO + net interest + paid dividends / financial expenses; 3. Short-term debt to EBITDA = Short-term debt / EBITDA; 4.
How do you calculate funded debt ratio? ›
The total funded debt — both current and long term portions — are divided by the company's total assets in order to arrive at the ratio. This ratio is sometimes expressed as a percentage (so multiplied by 100).
