Measuring how the company will repay The cash flow measure to use to evaluate a company's ability to repay debt depends on the company's expected operating results and financial condition. It also depends on the amount of discretion management has in reducing spending to meet mandatory debt repayments. When expected financial performance and condition are strong, you can safely assume that debt repayment will come from discretionary cash flow. If financial performance and condition deteriorate, the prudent assumption is that management can make more cash flow available for debt repayment by progressively reducing outlays over which it has the most discretion. Difficulty There is a declining trend in operating results, with growing net losses leading to operating losses.
Asset turnovers decrease and cash flow from operations also falls.
Financial leverage increases, mainly from reductions in net worth. Distress Increasing operating losses and slowing asset turnovers lead to negative cash flow from operations. Borrowing increases as a result. Leverage rises sharply on the combination of more debt and less net worth. The company breaches financial covenants in its loan agreements.