TABLE OF CONTENTS Cash flow analysis well may be the most important tool used by commercial and investment bankers to evaluate loans and value companies. Cash flow is literally the cash that flows through a company during the course of a quarter or the year after adjusting for noncash, nonoperating events. Lenders rely on cash flow statements because cash flows reveal both the degree by which historical and future cash flows cover debt service and borrowers' chances for survival. Cash flow is literally the firm's lifeblood. The greater and more certain the cash flows, the lower the default probabilities. Volatile cash flow is associated with weak bond ratings and higher default rates.
While the cash flow statement provides a "PRISM" (see Chapter 1) by which lenders peer into the future, there really is no substitute for in-depth knowledge of the firm, the industry in which the borrower operates, and the quality of management. In the final analysis, historical cash flows are simply offerings set by accounting information and guidelines, and they come to life only through the diligence, alertness, and the creativity of the minds that perceive them.
Revenue and profits power cash flows; all else is ancillary. But be wary. For example, a clothing manufacturer may make several large shipments of finished products shortly before the end of the fiscal year. The anticipated payment for these goods is booked as a debit to accounts receivable and a credit to revenue. While this transaction is recorded on the company's income statement,...
