CFA Level I Exam · Analyzing Statements of Cash Flows II

Cash Flow Performance and Coverage Ratios for CFA Level I

Updated 7 October 2026 · Fact-checked

Cash flow performance ratios compare operating cash flow (CFO) with revenue, assets, equity or income to show how well a firm turns activity into cash. Coverage ratios compare CFO with debt, interest, capex, dividends or total investing and financing outflows. To solve a question, pick the right formula, then divide.

Understand Cash Flow Performance and Coverage Ratios

Net income is an accounting number. Cash flow from operations (CFO) shows the cash the business actually generated from its core activities. Cash flow ratios use CFO to test the quality of earnings and the safety of the firm's obligations.

There are two families. Performance ratios ask how much operating cash the firm produces relative to something: revenue, assets, equity, operating income or shares. Coverage ratios ask whether that operating cash is enough to pay for something: debt, interest, capital expenditure, debt repayments, dividends, or all investing and financing outflows.

In every case CFO is the numerator (except interest coverage, where interest and taxes paid are added back). A higher ratio is generally better. A ratio below 1.0 in a coverage ratio means CFO alone does not cover the item, so the firm must use cash reserves, sell assets or raise new financing.

Ratios are most useful over time and against peers. A cash return on assets that falls while net income rises can signal weak earnings quality. Use average balances for assets and equity, because CFO is a flow over the year while the balance sheet is a point in time.

Key formulas to remember

Cash flow to revenue: CFO ÷ Net revenue; Operating cash generated per unit of sales.
Cash return on assets: CFO ÷ Average total assets; Use the average of opening and closing total assets.
Cash return on equity: CFO ÷ Average shareholders' equity; Use the average of opening and closing equity.
Cash to income: CFO ÷ Operating income; Shows how much operating income is backed by cash.
Cash flow per share: (CFO − Preferred dividends) ÷ Number of common shares outstanding; Preferred dividends are removed because they rank ahead of common shareholders.
Debt coverage: CFO ÷ Total debt; Higher means the firm can repay its debt from operations sooner.
Interest coverage: (CFO + Interest paid + Taxes paid) ÷ Interest paid; Adds back interest and taxes so CFO is measured before them. Check whether interest is already in CFO or in financing under the reporting standard.
Reinvestment: CFO ÷ Cash paid for long-term assets; Shows ability to fund capex from operations.
Debt payment: CFO ÷ Cash paid for long-term debt repayment; Ability to meet scheduled debt repayments from operations.
Dividend payment: CFO ÷ Dividends paid; Ability to pay dividends from operations.
Investing and financing: CFO ÷ Cash outflows from investing and financing activities; Ability to fund all investing and financing outflows internally.

How to solve Cash Flow Performance and Coverage Ratios questions

Use the same routine for any cash flow ratio question. It keeps you from mixing up the numerators and denominators.

1Decide whether the question is a performance ratio (compare CFO with revenue, assets, equity, income or shares) or a coverage ratio (can CFO pay for something).
2Write the exact formula before touching numbers.
3Pull CFO from the cash flow statement. Check whether the question gives CFO directly or asks you to build it first.
4For assets and equity, compute the average of the opening and closing balances unless the question says to use the ending balance.
5For interest coverage, add interest paid and taxes paid to CFO before dividing by interest paid.
6Use outflows as positive amounts in the denominator. Ignore the negative sign shown in the cash flow statement.
7Calculate, then sanity check: coverage below 1.0 means CFO falls short of the item.
8Pick the option that matches, then compare against the distractors built from common slips (wrong denominator, no average, missing add-back).

Quickest way: Match the denominator to the words in the question

When to use it: Use this when you have about 90 seconds and the question names the ratio or describes what it measures.

Numerator is CFO unless the ratio is interest coverage.
Translate the name: 'to revenue' means ÷ revenue; 'return on assets' means ÷ average assets; 'reinvestment' means ÷ capex.
Check the three options. Distractors are usually the same CFO divided by a different denominator from the data given.
Compute only the ratio you need, and use the calculator memory or a quick division.
If two options are close, re-check averages and the interest coverage add-backs.

Common mistakes in Cash Flow Performance and Coverage Ratios

Using ending assets or equity instead of the average.
The balance sheet shows the ending figure first and it is faster to use.
Fix: Add opening and closing balances and divide by 2 for cash return on assets and equity, unless told otherwise.
Forgetting to add back interest and taxes in interest coverage.
Students treat it like the income statement interest coverage and just divide CFO by interest.
Fix: Use (CFO + interest paid + taxes paid) ÷ interest paid. Think of it as cash flow before interest and taxes.
Using net income instead of CFO in the numerator.
Other ratios, like ROA, use net income, so it feels automatic.
Fix: Every ratio on this topic starts from operating cash flow. Net income does not appear.
Mixing up reinvestment and debt payment ratios.
Both are CFO divided by a cash outflow and the names sound similar.
Fix: Reinvestment uses cash paid for long-term assets (capex). Debt payment uses cash paid to repay long-term debt.
Reading a high ratio as good without context.
Students memorise 'higher is better'.
Fix: Compare with prior years and peers. A high ratio caused by cutting capex may not be sustainable.
Putting the negative sign from the statement into the denominator.
Investing and financing outflows appear in brackets.
Fix: Use the absolute size of the outflow so the ratio comes out positive.

Worked examples

Example 1

A company reports CFO of $600 million, net revenue of $4,000 million, average total assets of $5,000 million and average shareholders' equity of $2,400 million. What is its cash return on assets? A) 12.0% B) 15.0% C) 25.0%

Show the solution

Cash return on assets = CFO ÷ Average total assets.
= 600 ÷ 5,000 = 0.12, or 12.0%.
Check the distractors: 600 ÷ 4,000 = 15.0% is cash flow to revenue; 600 ÷ 2,400 = 25.0% is cash return on equity.

Answer: A) 12.0%

Example 2

A firm reports CFO of €900 million, interest paid of €60 million, taxes paid of €140 million, cash paid for long-term assets of €450 million and total debt of €3,000 million. What is its interest coverage ratio (cash flow basis)? A) 15.0x B) 16.0x C) 18.3x

Show the solution

Interest coverage = (CFO + Interest paid + Taxes paid) ÷ Interest paid.
Numerator = 900 + 60 + 140 = 1,100.
1,100 ÷ 60 = 18.33, or about 18.3x.
Check the distractors: 900 ÷ 60 = 15.0x ignores the add-backs; (900 + 60) ÷ 60 = 16.0x leaves out taxes.

Answer: C) 18.3x

Exam tips

The exam often gives a full cash flow statement and asks for one ratio. Find CFO first and ignore the rest.
Three-option questions usually include distractors built from the same numbers with the wrong denominator. Always say the ratio's name before dividing.
Know the interest coverage add-backs cold. It is the only formula that changes the numerator.
Interpretation questions ask what a ratio below 1.0 means: CFO does not cover the item, so external financing or cash reserves must fill the gap.
Check whether the question says average or ending balances before you compute.

Practice questions from Analyzing Statements of Cash Flows II

Cash Flow Performance and Coverage Ratios in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

FRM Part IILiquidity Coverage Ratio (LCR)

Cash Flow Performance and Coverage Ratios: frequently asked questions

What is the difference between performance and coverage cash flow ratios?

Performance ratios compare CFO with revenue, assets, equity, income or shares to measure how well the firm generates cash. Coverage ratios compare CFO with debt, interest, capex, dividends or total investing and financing outflows to test whether the firm can meet those needs from operations.

How do you calculate the cash flow interest coverage ratio?

Add interest paid and taxes paid to CFO, then divide by interest paid. This shows operating cash before interest and taxes relative to the interest bill. Add back interest and taxes only to the extent they were deducted in CFO. If interest paid is classified in financing under IFRS, it is not in CFO and should not be added back, so the numerator then adds only taxes paid.

What does a reinvestment ratio below 1.0 mean?

It means CFO is less than cash spent on long-term assets. The firm needs other sources, such as borrowing, new equity or asset sales, to fund its capex.

Do I use average or ending balances for cash return on assets?

Use average total assets, the mean of opening and closing balances, unless the question tells you to use another figure. CFO covers the whole period, so an average balance matches it better.