Description
The coverage ratio is used to determine the amount of actual cash distributions an MLP makes, relative to the amount it could potentially pay out. The amount of distribution which could be paid out is referred to as “Distributable Cash Flow” and is defined as:
Net Income + Depreciation, Depletion, and Amortization + Other Non-Cash Items – Maintenance Capital Expenditure
The coverage ratio is then calculated by dividing DCF by the actual cash distribution. Since MLPs will typically hold onto some DCF, this ratio will be greater than 1. Investors view a favorable coverage ratio as greater than 1.3, as this indicates the business has ample cash to continue paying distributions to unitholders.
Calculation
CR = Distributable Cash Flow / Actual Cash Distribution