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As an analyst, you are concerned about whether Arcadian Manufacturing Co. can generate a stream of inflows sufficient to pay interest expense. In the last three quarters, Arcadian's operating cash flows have been decreasing, but its operating profits have been increasing. Which one of the following ratios is the best one to use in this situation?
Correct Answer: C
The cash flow coverage ratio (operating cash flows before interest and tax payments/interest paid) discloses whether operating cash flows will be sufficient to pay interest on debt. Since the operating cash flows are decreasing, this ratio provides a more conservative result and is more appropriate to use than accrual based operating profit.