Funds from operations (FFO) to debt ratios are a measure of a company's ability to pay its debts using its operating income alone. Funds from operations includes money the company collects during the current year from inventory it sells and services it provides to its customers, and this entry is the same in every ratio. Several FFO-to-debt ratios are possible, because the company can compare its operating income to different types of debt.
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FFO-to-debt ratios are conservative ratios, because they do not include other sources of cash the company can use, such as income from selling equipment or issuing bonds. If a company's FFO-to-short-term-debt ratio is less than 1, the company has an immediate problem and will need to sell production equipment or take out another loan. An FFO-to-total-debt (or long-term debt) ratio below 1 may be acceptable if the company expects to increase its sales revenue without increasing its total debt load in future years.
Non-cash expenses are part of the FFO-to-debt ratios, according to Standard & Poor's. Some expenses a company incurs, such as depreciation on vehicles and production equipment, can be directly linked to operations. The company also can amortise certain costs, such as a fee that it pays for the right to use another company's patent for a period of 10 years. Tax liabilities reduce funds from operations instead of increasing debt.
FFO-to-debt ratios do not include bills for capital projects, according to Fitch Ratings. A capital project is a project the company undertakes to increase the number of products it can manufacture in the future, instead of maintaining its current production capacity, so capital project costs do not reduce the company's funds from operations. A free-cash-flow-to-debt ratio, which does include capital costs, will be lower than the comparable FFO-to-debt ratio.
Gross Profit Margin Comparison
Funds from operations are similar to gross profit margin, except it is a cash flow measure instead of a balance sheet measure. Gross profit margin includes all the revenue the company has the right to receive, so it includes non-cash asset accounts such as accounts receivable. Funds from operations includes money the company collects this year from sales it made last year, but it does not include sales the company makes this year if the customer will pay the bill next year.
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