Cash Flow Analysis FOCUSING THE UCA CASH FLOW FORMAT ON LENDING OPPORTUNITIES Various spread systems may be used to track cash flow. This article focuses on an adaptation of one such system—Uniform Credit Analysis®—to a format that the author calls “lender’s cash flow,” which helps bring more light to lending opportunities. This format is shown using a real-life example. by James C. Miller n 1987, RMA moved credit analysis from the complex and often marginal financial situations, horse-and-buggy days of traditional net-profit-plus- which require a more formal and detailed analysis. depreciation cash flow to the jet-age Uniform Credit Indeed, they may be open to leaving their current AnalysisI ® (UCA) format, a variant on the Financial banks because their current lenders calculate cash Accounting Standards Board’s FASB95® cash flow flow off the top of their heads, which may result in format. The UCA format, which calculates real cash an opinion that is less accurate and less favorable flow, is probably the best thing RMA has done for than that of company management. I suggest that the lenders since it started collecting and publishing limitations of the widely used informal “eyeballing” comparable peer data. techniques are a disadvantage, because most com- However, over the years, experienced commercial mercial lenders face aggressive loan-growth goals and lenders at large and small banks have told me that the need a reasonably precise and easily used tool to UCA cash flow is ignored in certain situations. It is not help them identify lending opportunities quickly and required in some banks’ loan approval write-ups. It is avoid wasting time on candidates that ultimately end not used by some vendor programs, such as LaserPro® up being unsuitable. (which produces loan documents), that use net profit plus depreciation in lieu of the UCA cash flow. Most Lenders’ Cash Flow important, though, it is not used by some lenders who, To solve that problem, I suggest a reorganization instead, go directly to companies’ financial statements of the UCA/FASB95 format, which I’ll call lenders’ to make “eyeball” estimates using net profit plus cash flow (LCF). LCF focuses on and directly dis- depreciation. plays precisely the lending opportunities for which In my experience, such informal estimates work experienced lenders look. This reorganization of the best when the situation is simple and obvious, and UCA format is not the first to be suggested1, and it less well in complex and marginal situations. First, does not attempt to address subtle accounting or accurate cash-flow calculations can be too complex theoretical nuances for obscure kinds of companies. for most lenders to do off the top of their heads. However, I believe it is the first to result in a sim- Second, most financial statements show periods of ple, easily used format designed specifically to help only two years—not enough to establish the impor- commercial lenders in the real world focus quickly tant trends and patterns. Third, the customers most on lending opportunities. likely to leave one bank for another tend to have © 2006 by RMA. James Miller is a vice president at Wells Fargo Bank NA, in Phoenix, Arizona. 84 The RMA Journal April 2006 Focusing the UCA Cash Flow Format on Lending Opportunities What do experienced find net profits and then because these assets are what lenders look for? In general, mentally add back interest, the loan supports most of the lenders tell me they look for three taxes, depreciation, and time. They look at the mag- things in the financial statement: amortization. nitude and estimated change 1. Some approximation of cash 2. Lending opportunities in in these assets to get an idea flow for debt repayment, to receivables and inventory, of the size of any loans to cover the change. When you Figure 1 think about it, these elements New “Lending New “Lending constitute the asset part of Opportunities in New “EBITDA/ NOI Current UCA Format Opportunities in Receivables & Interest Coverage” the trading asset or working CAPEX” Inventory” capital cash cycle. Revenues Revenues 3. Lending opportunities in capi- Changes in Receivables Changes in tal expenditures by examining Receivables the size and changes in fixed Cost of Goods Sold COGS Changes in assets, i.e., the asset portion of Changes in Inventory Inventory the capital expenditures cash Changes in Trade Payables Changes in Trade Payables cycle (CAPEX). These lenders Changes in Costs/Billings >Bills/Costs know that financing fixed Other Operating Revenues & assets is a time-honored way to Non-Trade Receivables Operating build large interest-income- Expenses Operating Expenses generating outstandings quick- Changes in Operating Balance Sheet ly. Very savvy lenders have Items found that sometimes terming Cash Payments for Income Taxes out high-equity fixed assets Changes in Flooring Line provides the cash to solve Net Cash from Operations many business problems. Cash CPLTD Payments (Current Portion of Long-term Debt) Reorganizing UCA with Three New Cash Interest Payments Focused Sections Dividends Figures 1 and 2 show how I reorganized the UCA format to Cash After Debt Amortization create three new sections that Non-Operating Income (Expense) focus on and present what the Fixed Assets Changed Fixed Assets Changed lenders look for. Cash Used for Investments Interest coverage. For the Other Asset Transactions interest repayment income Changes in Intangibles stream, i.e., cash flow approxima- Asset Sales/Extraordinary tion, I chose interest, taxes, Changes in Short-term Bank Debt Changes in Short- depreciation, and amortization term Bank Debt Changes in Long-term Debt Changes in (EBITDA) and accordingly Long-term Debt Changes in Subordinated Debt moved revenues, cash cost of sales, and cash operating expens- Changes in Other Liabilities and Affiliated Liabilities es to a section called New Changes in Other Liabilities & Gray Area “EBITDA / NOI Interest Changes in Net Worth Coverage.” I chose EBITDA, sometimes referred to as net oper- Net Change in Cash ating income (NOI), over the alter- Beginning Cash natives for four reasons: Net Change in Cash 1. It closely resembles the quick Ending Cash mental calculations experi- 85 Figure 2 neous items and put them into the proposed LCD in a Remaining UCA Proposed Lenders’ Cash Flow (LCF) Sources and Uses section. In actu- Operating Cash Flow Interest Coverage al practice, this section proves very Lending Opportunities in useful in tying up loose ends and Receivables & Inventory Miscellaneous Operating Cash Flow answering some questions that arise from the other sections. Debt Coverage Debt Coverage How It Works Investing Cash Flow Lending Opportunities in CAPEX Figures 3 and 4 show an exam- Financing Cash Flow Remaining Sources & Uses ple from real life. Figure 3 contains the income statement for the last enced commercial lenders CAPEX. Finally, I isolated the year and the balance sheet for two make and that, in actual prac- major elements that capture the periods, i.e., what is required to cal- tice, tend to be quickly CAPEX cash cycle—i.e., the culate cash flow. Figure 5 shows the accepted. changes in fixed assets and the cash flow derived from Figures 3 2. It has long been recognized changes in the long-term debt and 4 with the existing UCA format that interest repayment comes that should fund most of the in the two columns to the left and from the profits earned on the growth in fixed assets—and the proposed Lenders’ Cash Flow sale of the assets funded by moved them to a new section, in the two columns to the right. bank debt and that principal Lending Opportunities in Capital Notice that the existing UCA for- repayment comes from the liq- Expenditures (CAPEX). mat and the Lenders’ Cash Flow uidation of the funded asset. use identical line items and identi- Other Items. Remaining Well, EBITDA is the appro- cal Cash After Operations and Cash items in the Operating Cash Flow priate income stream that cov- After Debt Amortization figures. ers the interest portion. section of the UCA format include 3. There is widespread accept- miscellaneous operating cash flow EBITDA / NOI Interest ance2 of EBITDA in the gen- elements—mostly cash payments Coverage. Let’s start at the top eral financial community, for income taxes. I grouped these section in Figure 7, EBITDA / including commercial lenders line categories together in NOI Interest Coverage, the and prospective customers, so Miscellaneous Operating Cash Lenders’ Cash Flow format lets bankers and borrowers usual- Flow. In actual practice, moving us look at the cash flow approxi- ly speak the same language. these items out of Lending mation section. In this case, the 4. All the line items needed for Opportunities in Receivables and Lenders’ Cash Flow presented calculation are already present Inventory allowed for clearer focus the $11.8 million in revenues and in the existing UCA format. on the trading assets cash cycle. In then subtracted $6.994 million in addition, collecting these items in cash costs of sales3 and $3.970 Lending Opportunities in this new section made it easier to million in cash operating Receivables & Inventory. Next, examine them and catch anom- expenses4. The result was I isolated the major elements that alous amounts that influenced EBITDA, or NOI, of $846,000. capture the trading asset cash cash flow. This EBITDA covered $284,000 cycle, i.e., changes in receivables I left intact the classic UCA in interest 2.9 times. My experi- and inventory, the changes in Debt Coverage section, which ence is that this is strong for any trade payables, and the short-term includes the Cash After Operations kind of company. bank debt that funds those oppor- (CAO) and the Cash After Debt Normal EBITDA does not tunities.