A Systematic Integration of Strategic Analysis and Cash Flow Forecasting

Article excerpt

The introduction of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows," allows a uniform focus on net cash from operations as an indicator of loan repayment ability. The author explores the derivation of net cash from operations and how a borrower's strategic planning decisions directly affect the components of cash flow.

As lenders focus on repayment, they realize that loans can be repaid only with cash. When stock watchers and corporate treasurers analyze return on investments, they, too, address the adequacy of cash.

The Financial Accounting Standards Board (FASB) advanced the uniformity of cash flow analysis in 1988, when it used its Statement of Financial Accounting Standards (SFAS) No. 95, "Statement of Cash Flows." SFAS No. 95 expresses the dynamic nature of the cash cycle and demonstrates the integration of profitability and liquidity. Given the importance of the statement of cash flows in credit analysis, a lender who simply searches the statement for "positive cash flow" may be defeated in the purpose of evaluating future repayment ability.

Cash Flow Reporting

The dynamics of the income statement and the liquidity factors of the balance sheet of ABC Company (see Figure 1) are integrated by the direct or indirect method of the statement of cash flows shown in Figure 2. The simple statement of ABC Company and the actual generation of the statement of cash flows are not discussed in this article. However, lenders would do well to familiarize themselves with how a balance sheet, an income statement, and the statement of cash flows are related.

Figure 2 is included specifically to compare cash flow formats, to support discussion of the importance of net cash flow from operations, and to help identify critical cash flow factors or cash flow drivers. In addition to the two formats provided for by SFAS No. 95, the cash flow analysis format suggested by RMA's Uniform Credit Analysis (UCA [R]) is also included in Figure 2 for comparison purposes. The UCA [R] cash flow analysis is often found in bank credit analysis software and will, therefore, often be used with the statement of cash flows from a borrower's submitted financial statement.

The primary advantage of the SFAS No. 95 statements is the segregation of cash flow into cash flow from operations, from investing activities, and from financing activities. The cash flow from investing and financing activities is identical for SFAS No. 95's direct and indirect methods. Net cash flow from operations is derived in a different manner, but of course, the resulting figure is the same.

An analyst can observe how variables in the market, the industry, and the company's efficiency affect operational cash flow. The viability of future cash from operations can also be surveyed. Management decisions and options regarding capital expenditures and investments and financing necessity and availability should then be evaluated.

Net Cash Flow from Operations

The ABC Company's net cash flow from operations or net cash income figure (and that figure's relationship to investment and financing) demonstrates how profitability and depreciation are clearly not the only factors of cash flow. As a company experiences rapid growth or other changes, profits and noncash charges may play only a minor role in the flow of cash.

Profitability is required for a company to survive in the long run, but it is cash that runs the company from day to day. And most nonspeculative loans are expected to be repaid from net cash flow from operations.

Consider the cash flow of a company in which claims to cash might be greater than net cash flow from operations. Whether profitable or not, the company may have only two alternatives: liquidate investments or obtain additional financing.

Some important observations have been previously reported about cash flow from operations. …