Traditional Cash Flow versus UCA Cash Flow

One of the benefits of completing a formal credit training through a third party, is the exposure to different analysis procedures. My formal credit training was provided by the Risk Management Association (RMA) Commercial Lending School; and although it was short in duration compared to traditional institutional programs,
made an excellent accentuation to my real-life banking experience. I consider the course on the Uniform Credit Analysis (UCA) Cash Flow method invaluable because it is a debt service analysis tool created by bankers for bankers.

Traditional Cash Flow:

The traditional cash flow method relies solely on the income statement for calculating a company’s ability to repay its debts. The cash flow is created using a “bottom-up” approach beginning with net income and adding certain non-cash and cash expenses back to the cash flow. Expenses which are traditionally credited in the cash flow are amortization and depreciation
(non-cash), and interest and taxes (cash) creating what is known as earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA). Debt service through the traditional method is calculated by summarizing the company’s prior-year current portion of long term debt (CPLTD), current year interest expense, and the projected annual debt service from new debt facilities. EBITDA is divided by total debt service to create a debt
service coverage ratio (DSCR) which demonstrates the company’s ability to repay it’s debt. For example, a DSCR of 1.25x states based on the preceding, the company has enough cash flow to cover it’s debt payments by 125%.

UCA Cash Flow:

The UCA cash flow includes a mixture of balance sheet and income statement data which portrays actual changes to cash on hand from a year-to-year basis; which provides a multi-dimensional view into ability to service debt. Balance sheet items included which are not covered by the traditional cash flow include; but are not limited to, actual cash collected from sales, fluctuations in inventory levels, and changes to accounts payable. The cash flow gives an understanding of why cash increases
or decreases between any two periods. The UCA cash flow is split into two main categories; cash flow generated from operations after all core operating expenses have been removed, and the ensuing increases or decreases to cash. While the former is intricate to the UCA cash flow, for analysis purposes is highlighted as net cash after operations (NCAO). This is the equivalent starting point of net income when compared to the traditional cash flow.

The UCA cash flow utilizes a “top-down” approach beginning at NCAO and continuously reconciling how much cash a company has on-hand after a number of activities.  The cash flow can be broken into three sections; debt amortization, capital expenditures, and financing activities.

• Cash after debt amortization (CADA) highlights how much cash a company has on hand after paying its interest payments, shareholder dividends, and current year CPLTD. If CADA results in a negative figure, it demonstrates that a compay cannot pay it’s debt through it’s core operations.
• Capital expenditures, or fixed assets, is removed from the cash flow and demonstrates how much cash remains or financing required. A financing requirement does not automatically equate to a problem because many companies utilize debt to finance equipment upgrades, expansions, and etcetera. However, it is important to understand the difference between extraordinary expenditures and those required from a year to year basis.
• Financing activities demonstrate cash generated or reduced when borrowing or repaying loans. Traditional methods of borrowing funds include short term borrowings through a line of credit, long term borrowings through term facilities, and borrowing money from shareholders; and support working capital and capital expenditures. It is important to note that a -0- in this section doesn’t mean that no funds are outstanding, but that the loan amounts have not changed in a given period.

Ending cash is calculated by reconciling the cash surplus or deficit to beginning cash, and demonstrates funds available to service any new debt. The DSCR is calculated by dividing ending cash by the projected annual debt service from new debt facilities, providing an outlook into the company’s ability to repay. Similar to the traditional cash flow, a DSCR of 1.25x states based on the preceding, the company has enough cash flow to cover it’s debt payments by 125%.

The charts provided are from my final Commercial Lending School case study where  the company is purchasing its office and manufacturing facility from a third party, The charts highlight how the two methods can lead to conflicting results based on the exact same data.If you would like more details about this example, please view my writing sample.

Technorati Tags: Commercial Lending, RMA, Financial Statements, Traditional Cash Flow, UCA Cash Flow

Posted on April 9th, 2007 | By: bootstrap economist | Filed under Banking

One Response to “Traditional Cash Flow versus UCA Cash Flow”

1. The Bootstrap Economist :: Intermediate UCA Cash Flow Analysis Says:
   September 8th, 2007 at 12:51 pm

   [...] Links: Cash’s effect on the balance sheet. Traditional Cash Flow versus UCA Cash Flow [...]

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