Cash Flow Analysis
Cash Flow AnalysisFOCUSING THE UCA CASH FLOWFORMAT ON LENDING OPPORTUNITIESVarious spread systems may be used to track cash flow. This article focuses on anadaptation of one such system—Uniform Credit Analysis —to a format that theauthor calls “lender’s cash flow,” which helps bring more light to lendingopportunities. This format is shown using a real-life example.by James C. MillerIn 1987, RMA moved credit analysis from thehorse-and-buggy days of traditional net-profit-plusdepreciation cash flow to the jet-age Uniform CreditAnalysis (UCA) format, a variant on the FinancialAccounting Standards Board’s FASB95 cash flowformat. The UCA format, which calculates real cashflow, is probably the best thing RMA has done forlenders since it started collecting and publishingcomparable peer data.However, over the years, experienced commerciallenders at large and small banks have told me that theUCA cash flow is ignored in certain situations. It is notrequired in some banks’ loan approval write-ups. It isnot used by some vendor programs, such as LaserPro (which produces loan documents), that use net profitplus depreciation in lieu of the UCA cash flow. Mostimportant, though, it is not used by some lenders who,instead, go directly to companies’ financial statementsto make “eyeball” estimates using net profit plusdepreciation.In my experience, such informal estimates workbest when the situation is simple and obvious, andless well in complex and marginal situations. First,accurate cash-flow calculations can be too complexfor most lenders to do off the top of their heads.Second, most financial statements show periods ofonly two years—not enough to establish the important trends and patterns. Third, the customers mostlikely to leave one bank for another tend to havecomplex and often marginal financial situations,which require a more formal and detailed analysis.Indeed, they may be open to leaving their currentbanks because their current lenders calculate cashflow off the top of their heads, which may result inan opinion that is less accurate and less favorablethan that of company management. I suggest that thelimitations of the widely used informal “eyeballing”techniques are a disadvantage, because most commercial lenders face aggressive loan-growth goals andneed a reasonably precise and easily used tool tohelp them identify lending opportunities quickly andavoid wasting time on candidates that ultimately endup being unsuitable.Lenders’ Cash FlowTo solve that problem, I suggest a reorganizationof the UCA/FASB95 format, which I’ll call lenders’cash flow (LCF). LCF focuses on and directly displays precisely the lending opportunities for whichexperienced lenders look. This reorganization of theUCA format is not the first to be suggested1, and itdoes not attempt to address subtle accounting ortheoretical nuances for obscure kinds of companies.However, I believe it is the first to result in a simple, easily used format designed specifically to helpcommercial lenders in the real world focus quicklyon lending opportunities. 2006 by RMA. James Miller is a vice president at Wells Fargo Bank NA, in Phoenix, Arizona.84The RMA Journal April 2006
Focusing the UCA Cash Flow Format on Lending Oppor tunitiesWhat do experiencedlenders look for? In general,lenders tell me they look for threethings in the financial statement:1. Some approximation of cashflow for debt repayment, to2.find net profits and thenmentally add back interest,taxes, depreciation, andamortization.Lending opportunities inreceivables and inventory,Figure 1Current UCA FormatNew “LendingOpportunities inReceivables &Inventory”New “LendingOpportunities inCAPEX”RevenuesChanges in ReceivablesRevenuesChanges inReceivablesCost of Goods SoldChanges in InventoryChanges in Trade PayablesChanges in Costs/Billings Bills/CostsCOGSChanges inInventoryChanges inTrade PayablesOther Operating Revenues &Non-Trade ReceivablesOperatingExpensesOperating ExpensesChanges in Operating Balance SheetItemsCash Payments for Income TaxesChanges in Flooring LineNet Cash from OperationsCash CPLTD Payments(Current Portion of Long-term Debt)DividendsCash After Debt AmortizationNon-Operating Income (Expense)Fixed AssetsChangedFixed Assets ChangedCash Used for InvestmentsOther Asset TransactionsChanges in IntangiblesAsset Sales/ExtraordinaryChanges in Long-term DebtChanges in Subordinated DebtChanges in Other Liabilities andAffiliated LiabilitiesChanges in Other Liabilities & Gray AreaChanges in Net WorthNet Change in CashBeginning CashNet Change in CashEnding Cash3.Reorganizing UCA with Three NewFocused SectionsCash Interest PaymentsChanges in Short-term Bank DebtNew “EBITDA/ NOIInterest Coverage”because these assets are whatthe loan supports most of thetime. They look at the magnitude and estimated changein these assets to get an ideaof the size of any loans tocover the change. When youthink about it, these elementsconstitute the asset part ofthe trading asset or workingcapital cash cycle.Lending opportunities in capital expenditures by examiningthe size and changes in fixedassets, i.e., the asset portion ofthe capital expenditures cashcycle (CAPEX). These lendersknow that financing fixedassets is a time-honored way tobuild large interest-incomegenerating outstandings quickly. Very savvy lenders havefound that sometimes termingout high-equity fixed assetsprovides the cash to solvemany business problems.Changes in Shortterm Bank DebtChanges inLong-term DebtFigures 1 and 2 show how Ireorganized the UCA format tocreate three new sections thatfocus on and present what thelenders look for.Interest coverage. For theinterest repayment incomestream, i.e., cash flow approximation, I chose interest, taxes,depreciation, and amortization(EBITDA) and accordinglymoved revenues, cash cost ofsales, and cash operating expenses to a section called New“EBITDA / NOI InterestCoverage.” I chose EBITDA,sometimes referred to as net operating income (NOI), over the alternatives for four reasons:1. It closely resembles the quickmental calculations experi85
Figure 2UCAOperating Cash FlowDebt CoverageInvesting Cash FlowFinancing Cash Flow2.3.4.enced commercial lendersmake and that, in actual practice, tend to be quicklyaccepted.It has long been recognizedthat interest repayment comesfrom the profits earned on thesale of the assets funded bybank debt and that principalrepayment comes from the liquidation of the funded asset.Well, EBITDA is the appropriate income stream that covers the interest portion.There is widespread acceptance2 of EBITDA in the general financial community,including commercial lendersand prospective customers, sobankers and borrowers usually speak the same language.All the line items needed forcalculation are already presentin the existing UCA format.Lending Opportunities inReceivables & Inventory. Next,I isolated the major elements thatcapture the trading asset cashcycle, i.e., changes in receivablesand inventory, the changes intrade payables, and the short-termbank debt that funds those opportunities. I moved this cycle’s elements from their location in thecurrent UCA format to a new section, Lending Opportunities inReceivables & Inventory.Lending Opportunities in86The RMA Journal April 2006Proposed Lenders’ Cash Flow (LCF)Interest CoverageLending Opportunities inReceivables & InventoryMiscellaneous Operating Cash FlowDebt CoverageLending Opportunities in CAPEXRemaining Sources & UsesCAPEX. Finally, I isolated themajor elements that capture theCAPEX cash cycle—i.e., thechanges in fixed assets and thechanges in the long-term debtthat should fund most of thegrowth in fixed assets—andmoved them to a new section,Lending Opportunities in CapitalExpenditures (CAPEX).Other Items. Remainingitems in the Operating Cash Flowsection of the UCA format includemiscellaneous operating cash flowelements—mostly cash paymentsfor income taxes. I grouped theseline categories together inMiscellaneous Operating CashFlow. In actual practice, movingthese items out of LendingOpportunities in Receivables andInventory allowed for clearer focuson the trading assets cash cycle. Inaddition, collecting these items inthis new section made it easier toexamine them and catch anomalous amounts that influencedcash flow.I left intact the classic UCADebt Coverage section, whichincludes the Cash After Operations(CAO) and the Cash After DebtAmortization (CADA) subtotals.This means the subtotals and debtcoverage ratios are identical tothose of the current UCA format.I took the remaining miscella-neous items and put them into theproposed LCD in a RemainingSources and Uses section. In actual practice, this section proves veryuseful in tying up loose ends andanswering some questions thatarise from the other sections.How It WorksFigures 3 and 4 show an example from real life. Figure 3 containsthe income statement for the lastyear and the balance sheet for twoperiods, i.e., what is required to calculate cash flow. Figure 5 shows thecash flow derived from Figures 3and 4 with the existing UCA formatin the two columns to the left andthe proposed Lenders’ Cash Flowin the two columns to the right.Notice that the existing UCA format and the Lenders’ Cash Flowuse identical line items and identical Cash After Operations and CashAfter Debt Amortization figures.EBITDA / NOI InterestCoverage. Let’s start at the topsection in Figure 7, EBITDA /NOI Interest Coverage, theLenders’ Cash Flow format letsus look at the cash flow approximation section. In this case, theLenders’ Cash Flow presentedthe 11.8 million in revenues andthen subtracted 6.994 million incash costs of sales3 and 3.970million in cash operatingexpenses4. The result wasEBITDA, or NOI, of 846,000.This EBITDA covered 284,000in interest 2.9 times. My experience is that this is strong for anykind of company.Normal EBITDA does notadjust for changes in receivables,but for some companies, this canbe significant. As a result, theLenders’ Cash Flow also adjustsfor changes in receivables to pres-
Focusing the UCA Cash Flow Format on Lending Oppor tunitiesent Cash EBITDA (which wecould call CEBITDA). In thiscase, CEBITDA was a positive 758,000 to cover the 284,000 ininterest for a coverage ratio of 2.6.The format makes both optionsavailable so the lender can chosewhich is more appropriate.Lending Opportunities inReceivables & Inventory in theOperating Cash Cycle. Figure 7shows the lending opportunitiesin receivables and inventory inthe “Lending Opportunities inRec & Inv” section of the LCF.First we see changes in the twotrading assets—the receivablesand inventory—and then we seehow those assets are funded bytheir normal sources of funds,which are increases in short-termbank lines of credit and tradepayables. There is only a smalllending opportunity to supportreceivables because they onlyincreased 88,000. However,there is a substantial lendingopportunity in inventory, whichincreased 1.3 million this year,certainly a portion of which experienced lenders would want tofinance.Next, note that trading assets(inventory and receivables) grew ata combined rate of 56.4%, asopposed to revenue at 28.2%.Because revenues and tradingaccounts should move at roughlythe same rate, the faster growth intrading assets is a potential problem. On a dollar basis, the LCFshows that of the total 88,000growth in receivables, 89,000 wasrequired by the revenue growth5;however, only 601,000 of the 1.3million of inventory growth wasattributable to sales growth. TheLCF will help us find what causedthe portion of inventory growthnot attributable to sales growth.Now we need to lookat the two fundingsources—trade payablesand short-term bank linesof credit. Trading accountsincreased 1.371 million,but only a tiny portion ofthat was covered by the 85,000 increase in tradepayable, leaving 1.286 million to cover. The companyborrowed a total of 1.564million in new advances onits short-term bank line ofcredit, but this was 278,000 more than the 1.286 million actuallyneeded. Because we knowthe 278,000 in advanceson the line did not go intoinventory or receivables,we’ll use the LCF to findout where it may have gone.The possible misuse ofthe line of credit representsa potentially serious problem because it means availability on the line has nowbeen reduced at preciselythe time when the company needs increased availability to help support theincreased revenue growthfrom the new national retailcontracts. Incidentally, theFigure 7 section presentschanges in trading assets indollar amounts rather thanin turndays. That’s becausesaying, for example, thatyou need to lend four moreturndays is far less usefulthan saying you need tolend an additional 350,000. In real life, weasked this customer aboutthe increases in inventoryand he told us he had landed contracts with two largeretail chains for his kiteFigure 3Income Statement( 000s)RevenuesCost of SalesCost of Sales—DepreciationTotal Cost of SalesGross ProfitGeneral & Admin Exp.Interest ExpenseTotal Operating ExpensesOperating ProfitsInterest IncomeOther IncomePretax IncomeFederal Income TaxesNet ProfitsFY01 FY029,210 11,8105,449 6,9941561535,605 7,1473,605 4,6633,086 3,9702052943,291 4,2643143993436793534821647189475Figure 4Balance SheetAssets ( 000s)CashAccounts ReceivableLess Bad Debt ReserveTotal ReceivablesTotal InventoryInventory SuppliesTotal Current AssetsTotal Fixed AssetsNonOpL/T Invest in SubPrepaid Oth (Op) & DepositsDeffered Inc. Tax RecoverablesTotal Noncurrent AssetsTotal AssetsLiabilitesCredit Line—BanksCurrent Port. LT Debt—2Current Port. LT Debt—Capital LeaseTrade Accounts PayableOther AccrualsIncome Taxes PayableLoans From Related PartiesTotal Current LiabilitesLong-term Debt—2Long-term Debt—Capital LeaseTotal Noncurrent DebtTotal DebtCommom StockRetained EarningsTotal EquityTotal Debt 1,128257903,9444453974,04191,1751,1845,22587
products and built up inventory inthe third quarter to start deliveriesfor the Christmas season.Consequently, we can defensiblyconclude that the growth in inventory was “good” and probably represented a legitimate lendingopportunity. However, the company still borrowed more than itneeded and we need to find outwhy.Advances on short-term linesof credit other than flooring linesor notes payable real estate aregenerally not considered part ofnet cash after operations or netcash after debt amortization.6Consequently, the section contains an adjustment line toremove the 1.564 million inchanges in short-term bank debtfrom the calculations. This willalso allow the LCF to match theUCA’s CAO and CADA subtotals.Miscellaneous Cash Flow.Miscellaneous cash flow for mostcompanies is cash payments forincome taxes plus other minor,immaterial, and incidental cashinflows and outflows, the latter ofwhich are seldom significant.That’s why, if they are material,you should examine them to findtheir cause and see if they harmthe company. As it turns out, thisexample shows 63,000 paid incash for income taxes, but it alsoshows an anomaly—a 140,000cash outflow. When asked, thecustomer said he’d borrowed thisfrom the company for personaluses (and not for payment of personal taxes) before he landed thecontracts with the retail chains.A defensible conclusion isthat the owner’s draw may nothave harmed the company whenit was made before the contractswere signed, but now that cash is88The RMA Journal April 2006needed to support sales drivenhigher by the contracts, theabsence of the cash is harmful.But it also represents an opportunity for the lender to figure out away to lend reinjects the cashFigure 5Current UCA FormatProposed FormatEBITDA / NOI Interest CoverageRevenues11,810 RevenuesChanges in Receivables11,810(88) Cash Cost of Sales(6,994)COGS(6,994)Changes in Inventory(1,283) Cash Operating ExpensesChanges in Trade Payables% of Revenues(3,970)85Changes in Costs/Billings Bill Costs% of RevenuesEBITDA (NOI)7.2%(3,970) Interest Cash PaymentsChanges in Op. Balance Sheet ItemsCash Payments for Income TaxesChanges in Flooring Line-33.6%846Other Operating Rev & Non-Trade RecOperating Expenses-59.2%284(140) EBITDA / Cash Interest Expense2.963 CEBITDA (Adj for Rec)758.00% of RevenuesEBITDA / Cash Interest ExpenseCash Flow from EBITDA6.4%2.6 846Lending Opportunities inReceivables & InventoryReceivables (Increase) Decrease(88)Inventory (Increase) Decrease(1,283)Cash Absorbed into Trade Assets(1,371)Revenue Growth Rate28.2%Trading Account Growth Rate56.4%Receivables Change Due to Rev Growth(89)Inventory Change Due to CCOG Growth(601)Trade Payables Increase (Decrease)Short-term Bank Debt Increase (Decrease)Financing ProvidedFinancing Surplus (GAP)851,5641,649278Adjust Short-term Bank Debt(1,564)UCA Financing Surplus (GAP)(1,286)Miscellaneous Cash FlowChanges in Costs/Billings Bill/Costs0Other Op Rev & Non-Trade Rec0Changes in Op Balance Sheet ItemsCash Payments for Income TaxesMiscellaneous Cash Sources (Uses)Cash Flow (Net Cash From Operations)(643) Net Cash Flow After OperationsFigure 5 continues on the following page(63)(203)
Focusing the UCA Cash Flow Format on Lending Oppor tunitiesback into the company if suitablecollateral and repayment can befound. As it turns out, this suggested Lenders’ Cash Flow givesus the tools to do just that.Cash-Based Debt Coverage.Positive Net Cash Flow AfterOperations of a negative 643,000—less principal, interestpayments, and dividends—givesus Net Cash After DebtAmortization, which is identicalto the same subtotal in the UCAformat. If we use Net Cash FlowAfter Operations as a numeratorand the total of the items coveredas the denominator, we get a negative (1.7) debt coverage ratio(DCR). On the surface, negativeDCRs always look bad, butremember that this specific nega-Figure 5 (continued)Current UCA FormatProposed FormatCash-based Debt CoverageCash CPLTD PaymentsCash Interest PaymentsDividendsCash After Debt AmortizationNon-Operating Income (Expense)Cash Fixed AdditionsCash Used For Investments(81)Cash CPLTD Payments(294) Cash Interest Payments0 Dividends(294)0(1,018) Net Cash After Debt Amortization83(81)(1,018)Cash-based Debt Coverage(1.7)(800) Adjusted Used Short-term Bank Debt1,56415 Net Cash Flow Before CAPEXOther Asset Transactions546Lending Opportunities CAPEXChanges in IntangiblesYear-End Fixed Asset Equity931Asset Sales/ExtraordinaryCAPEX (Increase) Decrease(800)Changes in Short-term Bank DebtChanges in Long-term Debt1,56476Changes in Subordinated DebtChanges in Other Liabilities & AffiliatedLiabilitiesNet Change in Cash76CAPEX Financing Surplus (GAP)(724)Cash After CAPEX(178)90Changes in Other Liabilites & Gray AreaChanges in Net WorthL/T Debt Increase (Decrease)Remaining Sources and Uses SectionSources(16)Cash After CAPEX(6)Other and Accrued188Beginning Cash9 Net Worth Increased0Net Change in Cash0 Cash Account Decreased6Net Change in CashEnding CashActual Cash Flow Coverage(6)Total Sources1943 Uses(1.7)Cash Flow Shortfall After CAPEX(178)Other and Accrued0Net Worth Reduced(16)Total Uses(194)tive DCR was caused by production for the new contracts.Before we go any further, weneed to adjust back the changesin short-term bank debt, whichwe had previously removed tomatch the UCA’s CAO andCADA. This gives us cash flowbefore capital expenditures(CAPEX) of a positive 546,000.CAPEX Cash Cycle. Thethird thing the current UCA format does not display (after interestcoverage and lending opportunities in receivables and inventory),but which experienced lenderswant to see is the lending opportunities in CAPEX. Lending opportunities in CAPEX are second inimportance only to the opportunities in receivables and inventory.Not only does the CAPEX cyclerepresent a major source of lendingopportunities and problem-solvingfor bankers, but it also givesinsight into the financial sophistication of the borrower. Borrowerswith financial sophistication knowthey should match the life of theasset with the mat
n 1987, RMA moved credit analysis from the horse-and-buggy days of traditional net-profit-plus-depreciation cash flow to the jet-age Uniform Credit Analysis (UCA) format, a variant on the Financial Accounting Standards Board’s FASB95 cash flow format. The UCA format, which calculates re
Cash flow statements AS 3 cash flow statements IAS 7 statement of cash flows Ind AS 7 statement of cash flows Bank overdraft Financing activities Cash &cash equivalents Same as IFRS Cash flows from extra ordinary items to be classified as operating, financing and investing activities. Cash flow statements do not reflect any
Meaning : It is a statement that shows flow (Inflow or outflow) of cash and cash equivalents during a given period of time. As per Accounting Standard-3 (Revised) the changes resulting in the flow of cash & cash equivalent arises on account of three types of activities i.e., Cash flow from Operating Activities. Cash flow from Investing Activities.
C. Mulford: Cash Flow Analysis, p. 1 Analyzing Cash Flows Selected income statement data and a cash flow statement in the UCA format are provided below for 5 cases. Each case is a variation on the income and cash flow statement for the same company. In fact
Actual Cash Flow Statement Analysis An Actual Cash Flow Statement shows where cash actually came from and how it was used in the operation. It can be compared with a Projected Cash Flow Statement for the same year to assess the overall operation on a cash flow basis. This can be done on a quarterly basis as the year progresses if quarters in
Cash flow from Operations Cash flow from Investing Cash flow from Financing ÎWe will need to place each cash transaction and put it in one of the above sections. Remember, the total of the cash inflows less the outflows balance to the net change in the cash account from one year to the next. ÎThis is always the total of the cash account and the
To search the Cash Flow Process , follow these steps: 1. Navigate to the Cash Flow Process Summary page. 2. Enter the Name, Description, or Folder in Search Criteria. 3. Click the Search. Only Cash Flow Process that match the search criteria are displayed. 2.3 Create Cash Flow Process To create a new Cash Flow process, perform the following .
Statement of Cash Flow (Indirect Method) Cash flow from operating activities Sources: Cash Sales and collections of A/R Uses: Cost of goods sold Cash operating expenses . however, the methodology and format are quite different. The objective of the statement of cash flow is to show the three types of activities on a pure cash basis. However .
Cash Flow Analysis Cash flow is one of the appraisal techniques valuers usually used to advice prudent investors on the viability or otherwise of contemplated and/or ongoing real estate investment. Ogbuefi (2002) sees cash flows as analysis of cash outflow (expenditure) or cash in
