Business, Legal & Accounting Glossary
Asset Coverage Ratio provides a picture of the financial position of a company by comparing its assets (tangible and monetary) to its existing liabilities. The ratio allows the investors to reasonably predict the future earnings of the company and to assess the risk of insolvency.
The Assets Coverage Ratio is generally used as part of a larger liquidity analysis, which takes into consideration current liquidity requirements. working capital, and long-term financial obligations.
The Asset Coverage Ratio formula adds up all company’s current financial liabilities, excluding short-term debt; this amount is subtracted from the current value of total physical and monetary assets, excluding intangible assets such as customer goodwill.
The Asset Coverage Ratio calculation is normally performed using the asset book value. Unfortunately, the book value may vary significantly from the actual liquidation value of the asset. In order to get a realistic figure, the physical assets should be assessed at their liquidation or depreciated value, and not their original cost or book value. Failure to do so may result in misleading results and an overly optimistic view of the company’s finances.
Most companies should have a calculated asset coverage ratio of at least 2.0, except for utilities which can have a ratio as low as 1.5.
The Asset Coverage Ratio should be used in conjunction with other financial ratios to have a clearer picture of the company’s financial strengths and weaknesses.
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This glossary post was last updated: 22nd March, 2020