UCA Cash Flow Questions and Answers
In the Question and Answer segment of Webcast on the UCA Cash Flow Statement on October 15th, we responded to the questions submitted. However, we have repeated the questions (slightly edited in some instances) and have provided more detailed answers to each below.
A: Distributions from a Subchapter S corporation, partnership, limited liability company reporting as a partnership, and from a sole proprietorship are not taxable income and are not reported on the recipient's Form 1040. However, distributions from a Subchapter C corporation to owners do represent taxable income to the recipients and are reported initially on Schedule B and then carried through to Line 8 (I believe) on the Form 1040.
Tim asks . . .
Q1: Do you mind briefly explaining the difference between FASB and UCA cash flow statements.
A1: As I hope I mentioned in the webcast, Net Cash from Operating Activities does not include dividends or distributions. Those are classified as a Financing Activity in the FASB 95 Statement of Cash Flows. The UCA cash flow statement includes dividends, distributions,and withdrawals as operating events and includes them in the array of accounts that sum to Net Cash Income.
In addition, the FASB 95 statement does not break out current maturities of long-term debt due and payable in the year in question. Consequently, you must go back to the balance sheet to determine if Net Cash from Operating Activities, adjusted downward by dividends, distributions, or withdrawals, is sufficient to repay long-term debt as scheduled.
Further, the FASB 95 statement generally includes due to and due from related parties - at least if they are classified as current. The UCA cash flow statement groups all related party accounts in a separate category below capital spending but before the Financing Requirement.
Finally, the FASB 95 statement frequently includes short-term lines of credit, which are always classified as a financing activity in the UCA cash flow statement. For FASB 95, it's the accountant's choice. I've seen great variation in this classification decision.
Keep in mind that the FASB 95 statement is the last statement to come together. It's really an after-thought for the accountants.
Q2: You may wish to point out that income taxes for a C-Corp is treated as an operating expense under both FASB and UCA, so the separation of required and discretionary shareholder distribution is necessary.
A2: Good point. I hope I did so. However, I never consider any element of distributions to be discretionary. I think you have to assume initially that distributions are no more discretionary than salary. They likely are necessary to support a life-style, which is the most difficult thing in the world to alter or downsize. I think the burden of proof lies with the account office who makes that claim, and you can usually prove or disprove it by a thorough review of a personal cash flow statement. The problem in this area, however, is that the estimate for borrower living expenses is usually worthless - vastly understated.
To show my biases, I simply don't believe that distributions or loans to shareholders are discretionary. I am very skeptical they can be reduced in any subsequent period - especially now since the consumer debt burden is 130% of disposable income. Since I was born in Missouri, you have to show me.
Q3: I don't know if this is correct, but as a shortcut I take cash flow from ops (FASB) and add back in interest expense (an operating cost under FASB) to get cash flow after ops. It helps when you are just handed the f/s and are then expected to discuss the company.
A3: The shortcut I use is to reduce Net Cash Provided by Operating Activities by dividends, distributions, or withdrawals, then adjust the resulting balance for all related party transactions listed in the accounts that sum to Net Cash Provided by Operating Activities, and then adjust that balance further by any lines of credit included in those accounts. Once you've done so, you've arrived at Net Cash Income. To determine if that amount is sufficient to repay long-term debt as scheduled, match it against the prior year's current maturities of long-term debt.
Chris asks . . .
Q: In instances where we have significant A/P but no COGS how do we go about calculating the days in A/P? In yesterday’s example would Preliminary Site Costs replace COGS in the calculation? What about for other financials where A/P exists but no COGS?
A: If there is no COGS, I think most of the software systems will divide accounts payable by operating expenses and then multiple by 365. However, you could also divide accounts payable by sales, which would then give you the same base in comparing movements in A/R days with movements in A/P days. In running a company with no COGS, the managers would undoubtedly lean on their suppliers to offset the gap in collecting sales. The A/R days vis-a-vis A/P days comparison might be more helpful if both receivables and payables are measured against sales.
In addition, I sometimes like to lump accrued expenses with accounts payables, if the accruals are a relative big number, and then divide by sales or operating expenses and multiply by 365. From a cash flow perspective, managing accruals has the same impact as managing payables, particularly if the accrual amounts are relative large and, sometimes, larger than the payables.
Stephen asks . . .
Q: Since a distribution is cash into the owner's pocket, why wouldn't that be reported on a 1040?
A: Non-Subchapter-C Corporations do not pay taxes on the company profit. Subchapter-S Corporations., LLC's, Partnerships and sole proprietorships do not pay taxes on the profit they generate. The owners pay the taxes on the company profit. The owners do not pay taxes on the distributions.
Greg asks . . .
Q: What does UCA stand for?
A: UCA stands for Uniform Credit Analysis Most Banks use this format rather than the FASB 95 format.
Dan asks . . .
Q: What is the difference between a direct Cash Flow Statement and a UCA Cash Flow Statement as it relates to credit underwriting?
A: If you are fortunate enough to receive a statement of cash flows from a client or prospect, it will invariably be as FASB 95 statement. Three classification issue to look out for. As Rex explained, distributions and withdrawals are operating expenses. They are for taxes and compensation. Yet in the FASB 95 statement, distributions and withdrawals are classified as financing activities!
The second classification problem is that Related Party Transactions are classified with the operating cash flows in the FASB 95 statement. These related party transactions are moneys that affiliated companies lend to and from each other, moneys that the owners lend to the company, and so forth. Related parties transactions are quasi-financing activities and are so classified on the UCA statement. Clearly they are not operating cash flows.
The third classification issue is the classification of operating lines of credit. Sometimes, but not always, movements in the operating line of credit is classified with the operating cash flows. The CPA has the option of classifying the change in the operating line of credit with operating cash flows or with financing activities. Clearly, an increase or decrease in a bank line of credit is financing.
From an underwriting standpoint, distributions and withdrawals are operating cash flows, Related Party Transactions are quasi financing activities, and changes in the balance of an operating line of credit is financing.
Allison asks . . .
Q: If a borrower submits financial statements that are prepared on a cash basis (instead of accrual), is the UCA cash flow statement still relevant?
A: It depends. (The safe answer.) If you're reviewing a cash-based income tax return, the bottom line income or loss number includes a non-cash depreciation expense and does not include distributions and loans to shareholders. So you need to start with reported "cash" income, adjust it upward by the amount of depreciation expense, and then adjust it downward for the sum of a) distributions and b) loans to owners.
That gets you to Net Cash Income. Then you need to find CMLTD for the prior period, which may or may not be listed on Schedule L. From that point on, you'll need to construct the usual tail-end of the UCA cash flow statement, i.e., fixed asset spending, related party transactions, and changes in short and long-term debt.
If you're not working from a cash-based income tax return, then it's a matter of carefully understanding the format and the content of the statement you're working with. See if the format and content matches the UCA cash flow statement.
Finally, if you do get a cash-based income statement, always ask for the underlying accrual financial statements. You may find out that a company looks good on a cash basis, but had a significant accrual loss. It was able to hide the loss by running down receivables, running down inventory, and running up payables to produce a positive cash flow. If it did so, it likely has exhausted its financial flexibility, which means that the next year could be grim unless it can reverse its loss.
No simple answer, unfortunately.
Leslie asks . . .
Q: Are distributions ever taxed on the personal level? We didn't understand if you said that distributions were taxes from the C-Corps or if the C-Corp was the only entity that paid income taxes. We were thinking that distributions were never shown on the personal tax return.A: Distributions from a Subchapter S corporation, partnership, limited liability company reporting as a partnership, and from a sole proprietorship are not taxable income and are not reported on the recipient's Form 1040. However, distributions from a Subchapter C corporation to owners do represent taxable income to the recipients and are reported initially on Schedule B and then carried through to Line 8 (I believe) on the Form 1040.
Tim asks . . .
Q1: Do you mind briefly explaining the difference between FASB and UCA cash flow statements.
A1: As I hope I mentioned in the webcast, Net Cash from Operating Activities does not include dividends or distributions. Those are classified as a Financing Activity in the FASB 95 Statement of Cash Flows. The UCA cash flow statement includes dividends, distributions,and withdrawals as operating events and includes them in the array of accounts that sum to Net Cash Income.
In addition, the FASB 95 statement does not break out current maturities of long-term debt due and payable in the year in question. Consequently, you must go back to the balance sheet to determine if Net Cash from Operating Activities, adjusted downward by dividends, distributions, or withdrawals, is sufficient to repay long-term debt as scheduled.
Further, the FASB 95 statement generally includes due to and due from related parties - at least if they are classified as current. The UCA cash flow statement groups all related party accounts in a separate category below capital spending but before the Financing Requirement.
Finally, the FASB 95 statement frequently includes short-term lines of credit, which are always classified as a financing activity in the UCA cash flow statement. For FASB 95, it's the accountant's choice. I've seen great variation in this classification decision.
Keep in mind that the FASB 95 statement is the last statement to come together. It's really an after-thought for the accountants.
Q2: You may wish to point out that income taxes for a C-Corp is treated as an operating expense under both FASB and UCA, so the separation of required and discretionary shareholder distribution is necessary.
A2: Good point. I hope I did so. However, I never consider any element of distributions to be discretionary. I think you have to assume initially that distributions are no more discretionary than salary. They likely are necessary to support a life-style, which is the most difficult thing in the world to alter or downsize. I think the burden of proof lies with the account office who makes that claim, and you can usually prove or disprove it by a thorough review of a personal cash flow statement. The problem in this area, however, is that the estimate for borrower living expenses is usually worthless - vastly understated.
To show my biases, I simply don't believe that distributions or loans to shareholders are discretionary. I am very skeptical they can be reduced in any subsequent period - especially now since the consumer debt burden is 130% of disposable income. Since I was born in Missouri, you have to show me.
Q3: I don't know if this is correct, but as a shortcut I take cash flow from ops (FASB) and add back in interest expense (an operating cost under FASB) to get cash flow after ops. It helps when you are just handed the f/s and are then expected to discuss the company.
A3: The shortcut I use is to reduce Net Cash Provided by Operating Activities by dividends, distributions, or withdrawals, then adjust the resulting balance for all related party transactions listed in the accounts that sum to Net Cash Provided by Operating Activities, and then adjust that balance further by any lines of credit included in those accounts. Once you've done so, you've arrived at Net Cash Income. To determine if that amount is sufficient to repay long-term debt as scheduled, match it against the prior year's current maturities of long-term debt.
Chris asks . . .
Q: In instances where we have significant A/P but no COGS how do we go about calculating the days in A/P? In yesterday’s example would Preliminary Site Costs replace COGS in the calculation? What about for other financials where A/P exists but no COGS?
A: If there is no COGS, I think most of the software systems will divide accounts payable by operating expenses and then multiple by 365. However, you could also divide accounts payable by sales, which would then give you the same base in comparing movements in A/R days with movements in A/P days. In running a company with no COGS, the managers would undoubtedly lean on their suppliers to offset the gap in collecting sales. The A/R days vis-a-vis A/P days comparison might be more helpful if both receivables and payables are measured against sales.
In addition, I sometimes like to lump accrued expenses with accounts payables, if the accruals are a relative big number, and then divide by sales or operating expenses and multiply by 365. From a cash flow perspective, managing accruals has the same impact as managing payables, particularly if the accrual amounts are relative large and, sometimes, larger than the payables.
Stephen asks . . .
Q: Since a distribution is cash into the owner's pocket, why wouldn't that be reported on a 1040?
A: Non-Subchapter-C Corporations do not pay taxes on the company profit. Subchapter-S Corporations., LLC's, Partnerships and sole proprietorships do not pay taxes on the profit they generate. The owners pay the taxes on the company profit. The owners do not pay taxes on the distributions.
Greg asks . . .
Q: What does UCA stand for?
A: UCA stands for Uniform Credit Analysis Most Banks use this format rather than the FASB 95 format.
Dan asks . . .
Q: What is the difference between a direct Cash Flow Statement and a UCA Cash Flow Statement as it relates to credit underwriting?
A: If you are fortunate enough to receive a statement of cash flows from a client or prospect, it will invariably be as FASB 95 statement. Three classification issue to look out for. As Rex explained, distributions and withdrawals are operating expenses. They are for taxes and compensation. Yet in the FASB 95 statement, distributions and withdrawals are classified as financing activities!
The second classification problem is that Related Party Transactions are classified with the operating cash flows in the FASB 95 statement. These related party transactions are moneys that affiliated companies lend to and from each other, moneys that the owners lend to the company, and so forth. Related parties transactions are quasi-financing activities and are so classified on the UCA statement. Clearly they are not operating cash flows.
The third classification issue is the classification of operating lines of credit. Sometimes, but not always, movements in the operating line of credit is classified with the operating cash flows. The CPA has the option of classifying the change in the operating line of credit with operating cash flows or with financing activities. Clearly, an increase or decrease in a bank line of credit is financing.
From an underwriting standpoint, distributions and withdrawals are operating cash flows, Related Party Transactions are quasi financing activities, and changes in the balance of an operating line of credit is financing.
Allison asks . . .
Q: If a borrower submits financial statements that are prepared on a cash basis (instead of accrual), is the UCA cash flow statement still relevant?
A: It depends. (The safe answer.) If you're reviewing a cash-based income tax return, the bottom line income or loss number includes a non-cash depreciation expense and does not include distributions and loans to shareholders. So you need to start with reported "cash" income, adjust it upward by the amount of depreciation expense, and then adjust it downward for the sum of a) distributions and b) loans to owners.
That gets you to Net Cash Income. Then you need to find CMLTD for the prior period, which may or may not be listed on Schedule L. From that point on, you'll need to construct the usual tail-end of the UCA cash flow statement, i.e., fixed asset spending, related party transactions, and changes in short and long-term debt.
If you're not working from a cash-based income tax return, then it's a matter of carefully understanding the format and the content of the statement you're working with. See if the format and content matches the UCA cash flow statement.
Finally, if you do get a cash-based income statement, always ask for the underlying accrual financial statements. You may find out that a company looks good on a cash basis, but had a significant accrual loss. It was able to hide the loss by running down receivables, running down inventory, and running up payables to produce a positive cash flow. If it did so, it likely has exhausted its financial flexibility, which means that the next year could be grim unless it can reverse its loss.
No simple answer, unfortunately.
