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 formula for operation to debt ratio? ›
The calculation for the cash flow to debt ratio is very simple. You just need two numbers: your company's operational cash flow and its total debt. Once you have those figures, divide the former by the latter to get your company's cash flow to debt ratio percentage.
How to calculate FFO net debt? ›
To calculate the net FFO, one must add the non-cash expenses or losses that are not actually incurred from the operations, such as depreciation, amortization, and any losses on the sale of assets, to net income. Then subtract any gains on the sale of assets and interest income.
How is funds from operations calculated? ›
Funds from Operations (FFO) → The reconciliation process to compute funds from operations (FFO) begins with net income and adds back the depreciation of real estate assets, similar to the indirect cash flow method of arriving at cash from operations (CFO).
What is FFO funds from? ›
Funds From Operations (FFO) for a REIT: Meaning, Calculations, and Real-Life Usage. For Equity REITs, Funds from Operations (FFO) equals Net Income + Real Estate-Related Depreciation & Amortization + Losses / (Gains) on Property Sales + Impairments.
How is FFO payout ratio calculated? ›
FFO Payout Ratio, Total - % represents the Company level FFO Payout Ratio, as reported by the company. It shows the dividend payout rate from the Funds from Operations (FFO) for each share. It is obtained using Dividends per Common share divided by Funds from Operations per share.
What does Price to FFO tell you? ›
P/FFO, or Price to Funds From Operations, can be described as a reliable and modern way of determining the value of a Real Estate Investment Trust (REIT).
What is the formula for debt to total funds ratio? ›
A company's debt ratio can be calculated by dividing total debt by total assets. A debt ratio of greater than 1.0 or 100% means a company has more debt than assets while a debt ratio of less than 100% indicates that a company has more assets than debt.
The total debt-to-total assets ratio is calculated by dividing a company's total debt by its total assets. This ratio shows the degree to which a company has used debt to finance its assets. The calculation considers all of the company's debt, not just loans and bonds payable, and all assets, including intangibles.
What is the formula for ratio? ›
Ratios compare two numbers, usually by dividing them. If you are comparing one data point (A) to another data point (B), your formula would be A/B. This means you are dividing information A by information B. For example, if A is five and B is 10, your ratio will be 5/10.
What is the FFO to total debt ratio? ›
FFO-to-Debt = FFO / Total debt
A type of leverage ratio which measures a firm's FFO to its total debt. A higher ratio indicates more cash flow to service debt, and hence lower credit risk.
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 an example of funds from operations? ›
For example, for a company selling jewellery, income from investments or a one-time sale of a fixed asset could be considered non-operating income. Removing such non-operational transactions gives you the funds from operations.
What is the FFO payout ratio? ›
FFO Payout Ratio, Total - % represents the Company level FFO Payout Ratio, as reported by the company. It shows the dividend payout rate from the Funds from Operations (FFO) for each share. It is obtained using Dividends per Common share divided by Funds from Operations per share.
What is the funds from operations interest coverage ratio? ›
Related to Funds From Operations Interest Coverage Ratio. Interest Coverage Ratio means, as at any date, the ratio of (a) EBITDA for the period of four consecutive fiscal quarters ending on or most recently ended prior to such date to (b) Interest Expense for such period.
