Using Cash Flow Statements and Proxies for Risk Assessment examines the ability of cash flow statements – the Uniform Credit Analysis (UCA) cash flow statement and the FASB 95 Statement of Cash Flows – and cash flow proxies – traditional "cash flow" and EBITDA – to properly identify the four fundamental issues that must be addressed in every credit request:
- The borrowing causes.
- The cash sources of interest-bearing debt service.
- The financing requirement.
- The sources of cash used by the company to meet its financing requirement.
At the end of the four online sessions, participants will understand the benefits and limitation of each cash flow statement and cash flow proxy in resolving the fundamental issues. In the process, they will explore how to calculate the cash impact of movements in the Business Drivers in explaining operating cash flow results and assessing a borrower’s competence in managing its income statement, balance sheet, and operating cash flow. Finally, participants will understand how to adjust the cash flow proxies so they represent measures of borrower debt capacity, which work in tandem with operating cash flow in assessing borrower risk.
Target Audience
Analysts, lenders, relationship officers, and branch managers interested in mastering cash flow techniques in reaching a credit decision.
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1. UCA Cash Flow Statement, Traditional "Cash Flow," and EBITDA
... cash is king
In this first session of the Course, which runs approximately two hours including a rest break, participants identify the financial information necessary to construct a Uniform Credit Analysis (UCA) cash flow statement and explore the reasons for incorporating balance sheet information in the construction and use of a comprehensive cash flow statement. They manually construct a UCA cash flow statement and assess the content and relevance of each section in the UCA cash flow statement in identifying 1) borrowing causes, 2) cash sources of interest-bearing debt service, 3) the financing requirement or surplus, and 4) the sources of cash to meet a financing requirement for a borrower or prospective borrower. In addition, participants contrast UCA cash flow results and signals about borrower cash flow adequacy with two cash flow proxies - traditional "cash flow" and EBITDA - in exploring the analytical limitations of cash flow proxies based solely on income statement information.
Target Audience:
Analysts and lenders interested in exploring the construction and use of the Uniform Credit Analysis (UCA) cash flow statement in assessing borrower risk, as well as examining the relevant similarities and differences between traditional cash flow - net income plus non-cash charges - as a proxy for cash flow and the UCA cash flow statement in idenifying 1) borrowing causes, 2) cash sources of interest-bearing debt service, 3) the financing requirement or surplus, and 4) the sources of cash to meet a financing requirement for a borrower or prospective borrower.
Prerequisites:
A working knowledge of accounting concepts and principles, including familiarity with debits and credits, along with an understanding of the generic credit decision process.
Objectives:
By the end of the session, participants will be able to:- Identify the financial information necessary to construct a UCA cash flow statement.
- Understand the importance of linking balance sheet accounts to specific income statement accounts in the process of integrating the balance sheet and income statement into a cash flow statement.
- Implement the step-by-step mechanical process of constructing the UCA cash flow from accrual balance sheet and income statement information.
- Identify 1) the borrowing causes, 2) the sources of cash used by the borrower to service interest-bearing debt, 3) the financing requirement or financing surplus, and 4) the source of cash to meet the financing requirement, if one exists, by reference to the UCA cash flow statement.
- Understand the limitations of traditional "cash flow" and EBITDA in identifying 1) the borrowing causes, 2) the sources of cash used by the borrower to service interest-bearing debt, 3) the financing requirement or financing surplus, and 4) the source of cash to meet the financing requirement if one exists.
- Identify differences in debt service coverage based on traditional "cash flow" and EBITDA compared to debt service coverage based on information in the UCA cash flow statement.
Materials and Preparation for this Course:
- Credit Refresher on The ABCs of Cash Flow
- Excerpts from Financial Statements
- Exercise for the Webinar
- Webinar Presentation Slides
- Webinar Poll Questions
Preparation
As preparation for the webinar, please:
- Read the Credit Refresher.
- Review the accrual financial statements
- Complete as many of the steps in the exercise as time allows prior to the webinar.
Two to three hours, including reading and preparation time.
2. Cash Impact Analysis, Borrowing Causes Revisited, and Management Assessment
... a cash flow proxy is not cash flow
In this second session of the Course, which runs approximately two hours including a rest break, participants explore and master the methodology for computing the dollar amount of cash inflow or outflow from sales growth and from changes in EBITDA%, accounts receivable days, inventory days, and accounts payable days. In doing so, they confirm, clarify, reduce, or expand the operating borrowing causes identified Session 1 as well as identify the areas of management strengths and weaknesses in controlling a company's income statement, balance sheet, and operating cash flow.
Target Audience:
Analysts and lenders interested in understanding and applying an analytical methodology that confirms, reduces, or expands borrowing causes identified in the UCA cash flow statement and assesses management’s ability to control the company’s income statement, balance sheet, and operating cash flow based on cash impact analysis.
Prerequisites:
A sound working knowledge of the construction and use of the UCA cash flow statement and, preferably, participation in Session 1 of the Course.
Objectives:
By the end of the session, participants will be able to:- Identify the likely reasons a borrower failed to generate sufficient business cash flow to service its debt, given a completed UCA cash flow statement and a set of financial performance measures.
- Quantify the cash impact of changes in EBITDA%, accounts receivable, inventory, and accounts payable days and determine whether these collective changes contributed to or reduced business cash flow available to meet debt service.
- Quantify the cash impact of sales growth or decline and determine whether sales growth contributed to or reduced business cash flow available to meet debt service.
- Determine if the changes in EBITDA%, accounts receivable, inventory, and accounts payable days add to or reduce the cash impact of sales growth or decline.
- Assess a borrower's ability to effectively manage its income statement and balance sheet, and identify areas of success and failure and their relevance to company cash flow performance.
- Identify the critical issues management must address if the borrower is to achieve sufficient business cash flow in the coming year to properly service its debt.
Materials and Preparation for this Course:
- Credit Refresher on Balance Sheet Management
- Credit Refresher on Income Statement Management
- Excerpts from the Financial Statements
- Exercise for the Webinar
- Webinar Presentation Slides
- Webinar Poll Questions
Preparation
As preparation for the webinar, please:
- Read the two Credit Refreshers.
- Review the excerpts from the financial statements.
- Complete as many of the steps in the exercise as time allows prior to the webinar.
Two to three hours, including reading and preparation time.
3. FASB 95 Statement of Cash Flows Conversion to UCA Cash Flow Statement
... accountants' cash flow versus lenders' cash flow
In this third session of the Course, which runs approximately two hours including a rest break, participants explore and compare the form and structure of the FASB 95 Statement of Cash Flows, which is a standard report in every financial package, with the form and structure of the UCA cash flow statement. They identify differences in account classification that have a material impact on one or more of the four sections of both cash flow statements - the operating cash flow section, the investment section, the related parties section, and the financing section. They identify the limitations in the FASB 95 Statement of Cash Flows in properly identifying the 1) borrowing causes, 2) cash sources of interest-bearing debt service, 3) the financing requirement or surplus, and 4) the sources of cash to meet a financing requirement for a borrower or prospective borrower. In addition, participants examine the steps required to quickly transform the FASB 95 Statement of Cash Flows to the UCA cash flow statement, thereby correcting the analytical flaws associated with the FASB 95 Statement of Cash Flows.
Target Audience:
Analysts and lenders interested in a comprehensive examination of the use, limitations, and analytic value of the FASB 95 Statements of Cash Flows in identifying 1) borrowing causes, 2) cash sources of interest-bearing debt service, 3) the financing requirement or surplus, and 4) the sources of cash to meet a financing requirement for a borrower or prospective borrower as well as exploring the few adjustments necessary to conform the FASB 95 Statement of Cash Flows to the UCA cash flow statement, thereby correcting its analytical flaws.
Prerequisites:
A sound working knowledge of the construction and use of the UCA cash flow statement as well as general familiarity with the FASB 95 Indirect Statement of Cash Flows and, preferably, participation, in Sessions 1, 2, and 3 of the Course.
Objectives:
By the end of the session, participants will be able to:- Identify the purpose, composition, and structure of the FASB 95 Statements of Cash Flows and the manner in which its composition and structure, in particular, differ from the composition and structure of the UCA cash flow statement.
- Identify and appreciate the cash flow impact resulting from the difference in classification of distributions on a) operating cash flow in the FASB 95 Statements of Cash Flows and on b) operating cash flow in the UCA cash flow statement.
- Identify the cash flow impact resulting from the difference in classification of loans to and from owners on a) operating cash flow in the FASB 95 Statements of Cash Flows and on b) operating cash flow in the UCA cash flow statement.
- Identify the cash flow impact resulting from the difference in classification of short-term credit lines on a) operating cash flow in the FASB 95 Statements of Cash Flows and on b) operating cash flow in the UCA cash flow statement.
- Identify and provide reasons for the likely different conclusions and messages about a borrower's ability to service its interest-bearing debt based on the FASB 95 Statements of Cash Flows versus a UCA cash flow statement.
- Identify the steps necessary to quickly conform the FASB 95 Statement of Cash Flows to the UCA cash flow statement, thereby correcting the analytical flaws in the FASB 95 Statement of Cash Flows.
Materials and Preparation for this Course:
- Credit Refresher on FASB 95 Statement of Cash Flows
- Financial Statements
- Exercise for the Webinar
- Webinar Presentation Slides
- Webinar Poll Questions
Preparation
As preparation for the webinar, please:
- Read the Credit Refresher.
- Review the financial statements.
- Complete as many of the steps in the exercise as time allows prior to the webinar.
Two to three hours, including reading and preparation time.
4. Cash Flow Proxies, Debt Capacity, and the UCA Cash Flow Statement
... it all begins with accrual profit
In this fourth session in the Course, which runs approximately two hours including a rest break, participants explore the concept of debt capacity, based on simple adjustments to the cash flow proxies, and its importance in assessing a borrower's prospects for properly servicing its interest-bearing debt. They identify the roles of dividends, distributions or withdrawals, income taxes, and loans to owners or partners in arriving at an estimate of existing and prospective debt capacity. In addition, participants determine reasons for apparent conflicts between debt capacity estimates and actual operating cash flow and explore how the two risk metrics work in tandem in assessing borrower risk. They review the importance of quality financial information in validating debt capacity estimates, and they identify the range of corrective measures available to both borrower and lender should a borrower's debt capacity fail to support outstanding, or proposed, interest-bearing debt.
Target Audience:
Analysts and lenders interested in reviewing the fundamental considerations that shape the concept of debt capacity, in examining methodologies for computing estimates of debt capacity, and in identifying the different roles for debt capacity and operating cash flow in assessing borrower risk.
Prerequisites:
Familiarity with financial statements, ratio analysis, cash flow proxies such as EBITDA and traditional "cash flow", and the UCA cash flow statement and, preferably, participation in Sessions 2, 3, and 4 of the Course.
Objectives:
By the end of the session, participants will be able to:- Understand and state the concept of debt capacity and its importance in assessing a borrower's ability to properly service its interest-bearing debt.
- Identify and understand the necessary adjustments to the cash flow proxies that transform them to a measure of debt capacity.
- Identify the role that dividends, distributions, withdrawals, and loans to owners and partners play in estimating debt capacity.
- Identify the reasons for differences in cash flow proxies and the UCA cash flow statements in measuring a company's ability to service its interest-bearing debt.
- Assess the importance of apparent conflicts between estimates of debt capacity and operating cash flow performance in a given period of time and explore the complementary use of both risk metrics working in tandem to assess borrower creditworthiness.
- Identify the possible corrective measures at the disposal of a borrower and its lender should the borrower lack sufficient debt capacity to properly service its debt.
Materials and Preparation for this Course:
- Credit Refresher on Debt Capacity
- Excerpts from Financial Statements - Information Access, Inc.
- Excerpts from Financial Statements - Sandover Contractors, Inc.
- Exercise for the Webinar
- Webinar Presentation Slides
- Webinar Poll Questions
Preparation
As preparation for the webinar, please:
- Read the Credit Refresher.
- Review the financial statements.
- Complete as many of the steps in the exercise as time allows prior to the webinar.
Two to three hours, including reading and preparation time.