Key Takeaways
- Measures company's ability to cover debt with tangible assets.
- Higher ratio means lower financial risk and better credit terms.
- Excludes intangible assets for accurate debt coverage assessment.
What is Asset Coverage Ratio?
The Asset Coverage Ratio (ACR) measures a company's ability to cover its debt obligations using its tangible assets, excluding intangibles like goodwill. It serves as a key metric to assess financial risk and creditworthiness by indicating how many times a company’s physical assets can repay its debts.
Analysts and lenders often review the ACR alongside other metrics such as interest coverage and weighted average cost of capital to evaluate a company's financial health and borrowing capacity. You can find detailed asset and debt figures in a company’s 10-K filings.
Key Characteristics
The Asset Coverage Ratio highlights a firm's solvency by focusing on tangible asset backing for debt. Key features include:
- Focus on Tangible Assets: Excludes intangible assets to emphasize liquidatable resources like property and equipment.
- Debt Comparison: Compares net tangible assets against total debt, including both short- and long-term obligations.
- Risk Indicator: A higher ratio signals lower default risk and stronger collateral for creditors.
- Industry Variability: Asset-heavy sectors such as utilities or manufacturing usually maintain higher ratios.
- Balance Sheet Data: Relies on financial statements and T-account analysis for accurate computation.
How It Works
The Asset Coverage Ratio is calculated by subtracting intangible assets and non-debt current liabilities from total assets, then dividing by total debt. This approach ensures that only tangible and readily liquidatable assets are considered for debt coverage.
For example, a company with $200 million in total assets, $20 million in intangibles, $80 million in current liabilities (including $20 million short-term debt), and $60 million total debt would have an ACR of 2.0x. This means it can cover its debts twice over with tangible assets, signaling financial strength to investors and lenders.
Examples and Use Cases
Understanding the Asset Coverage Ratio helps you compare companies across industries based on their asset backing and debt levels. Consider these examples:
- Airlines: Delta maintains substantial tangible assets like aircraft and facilities, influencing its asset coverage ratio and credit terms.
- Bond Investments: Investors analyzing bond issuers often review ACR to assess the risk of default based on asset collateral.
- Banking Sector: When evaluating bank stocks, ACR complements other solvency metrics to determine safety and capital adequacy.
Important Considerations
While the Asset Coverage Ratio provides insight into a company’s ability to meet obligations, it does not account for operational cash flow or market value fluctuations of assets. You should also consider liquidity, industry norms, and potential asset impairments when interpreting the ratio.
Ultimately, ACR is one of several financial metrics to evaluate alongside your broader investment analysis, including understanding a company’s obligations and capital costs. This holistic approach ensures a well-rounded view of financial stability and risk exposure.
Final Words
A strong asset coverage ratio indicates a company’s solid ability to meet debt obligations through tangible assets, reducing creditor risk. To assess your investment or lending options, compare the ACR across potential companies to identify those with healthier balance sheets.
Frequently Asked Questions
Asset Coverage Ratio (ACR) measures a company's ability to repay its debt by liquidating tangible assets, excluding intangibles like goodwill. It helps assess financial risk and creditworthiness by showing how many times assets can cover total debt.
A common formula is (Total Assets minus Intangible Assets) minus (Current Liabilities minus Short-Term Debt), divided by Total Debt. This focuses on tangible assets available to cover debt obligations.
Intangible assets like goodwill or patents are excluded because they are hard to value and cannot be easily liquidated to repay debt. The ratio focuses on tangible, liquidatable assets for a more accurate risk assessment.
A high ACR, typically above 2.0x, means the company has strong asset backing to cover its debts multiple times, signaling lower bankruptcy risk and better creditworthiness to lenders and investors.
An ACR below 1.0 indicates that a company’s tangible assets are insufficient to cover its total debt, which implies a higher risk of bankruptcy and financial instability.
Lenders, investors, and analysts use the ACR to evaluate a company's solvency, bankruptcy risk, and borrowing capacity. It helps them understand the company’s capital structure and creditworthiness.
Yes, while the most common formula excludes intangible assets and adjusts current liabilities, there are variations that simplify or broaden the components. Each version has a slightly different focus but aims to assess asset support for debt.
ACR complements cash flow metrics like interest coverage by focusing on tangible asset backing rather than earnings. Together, they provide a fuller picture of a company’s ability to meet debt obligations.
