Cash flow analysis entails a search for the fundamental drivers that underlie a company’s cash flow

stream. The preparation of what we refer to as a cash flow analysis statement, a variation of the UCA®
format referred to earlier, is a very useful starting point. The cash flow analysis statement is an income
statement and balance sheet change approach to preparing a cash flow statement. Exhibit 1.14
presents the cash flow analysis statement up to the line item referred to as adjusted cash flow from
operations. The cash flow analysis statement is useful in clarifying sustainable sources and uses of
cash. However, before completing the statement, it is important to carefully review the financial
statements and footnotes to identify misclassified and nonrecurring items, discussed earlier, that may
lead to misguided cash flow calculations. Where needed, adjustments and reclassifications should be
made to the items presented on the cash flow analysis statement to ensure that the statement format
highlights sustainable and nonsustainable sources and uses of cash. Preparation and use of the cash
flow analysis statement is discussed in Chapter 9.

Exhibit 9.4 presents a format for the cash flow statement that is useful in analysis. Parts of it are
similar to the Uniform Credit Analysis® (UCA)® format of the cash flow statement presented in
Chapter 1. Lenders and other credit professionals often use the UCA® format cash flow statement
when analyzing cash flow. However, we have introduced changes that adjust for, and at times
reclassify, certain operating items and remove nonrecurring items as noted in earlier chapters.
Moreover, the design of the cash flow analysis statement considers the needs of equity analysts and
investors. Cash flow statements prepared in accordance with generally accepted accounting principles
(GAAP) report only three main categories of cash flow: cash provided or used by operating, investing,
and financing activities. Operating cash flow in a GAAP-based indirect- method format starts with
net income and reconciles to a single cash flow figure, cash provided by operating activities. A
GAAP-based direct-method format presents the actual cash flows comprising cash provided by
operating activities, categories of cash flow such as cash collected from customers and cash paid to
suppliers. Operating cash flow is computed by summing these operating-related cash flow items. As
seen in Exhibit 9.4, the cash flow analysis statement is a combination of the indirect and direct
formats. Similar to an indirect-method cash flow statement, the cash flow analysis statement provides
a reconciliation of income to cash flow. However, rather than only reconciling net income to operating
cash flow, on the cash flow analysis statement each line item of the income statement is reconciled
to its cash flow counterpart. For example, among the line items presented on the statement, revenue
is reconciled to cash from revenue by removing balance sheet changes in operating receivables and
deferred revenue. Similarly, cost of revenue is reconciled to the cash cost of revenue by removing
depreciation and amortization expense and changes in inventory and operating payables. Also,
selling, general, and administrative expense and research and development expense are reconciled to
cash operating expense by removing, in addition to depreciation and amortization expense, changes
in prepaids and accruals. Similar to the presentation on a direct-method cash flow statement, each
resulting cash flow item—for example, cash from revenue, cash cost of revenue, and cash operating
expense—is an actual source or use of cash for a particular function. Added to the cash flow analysis
statement are key subtotals, such as cash gross margin and core operating cash flow. These subtotals
help the analyst more readily determine if sources of cash are sufficient to cover key operating needs.
Both the indirect and direct cash flow statements present key components of cash provided or used
by investing activities drawn to a single total. Cash provided or used by

financing activities is presented similarly. No distinction is made among priorities of various claims.
The cash flow analysis statement can be considered to be a cash flow coverage statement, as it uses
subtotals to highlight whether superior claims on cash flow are being covered by cash collections.
For example, interest paid is subtracted from cash available for debt service to derive cash flow from
operations. From this subtotal, required principal payments on long-term debt and capital lease
1
obligations are subtracted to yield cash flow after debt service. Dividends then are subtracted to yield
cash flow after dividends, which is cash available for investments and capital expenditures.
Subtracting investments and capital expenditures yields the change in cash before external financing.
As the title suggests, cash would have increased or decreased by this amount in the absence of any
external financing, whether through debt or equity. The actual change in cash and equivalents is
determined once external financing and the change in accumulated other comprehensive income are
taken into account.6 In preparing the cash flow analysis statement, revenue and other income items
should be recorded as sources of cash, that is, as positive amounts. Decreases in assets as well as
increases in liabilities and shareholders’ equity accounts also are entered as sources of cash. Expenses
and dividends, as well as increases in assets and reductions in liabilities and shareholders’ equity,
should be entered as uses of cash. As noted, the cash flow analysis statement format is attuned to
adjustments to reclassify certain operating items and remove nonrecurring items discussed in earlier
chapters. For example, capitalized operating expense is included with cash operating expense, which
is part of core operating cash flow. On a GAAP-based cash flow statement, often such costs are
reported as part of cash used for investing activities. When interest is capitalized to inventory or
property, plant, and equipment, it is reclassified on the cash flow analysis statement to total interest
paid. On the cash flow analysis statement, cash invested in trading securities is reported as part of
cash paid for investments and is not included with cash provided by operating activities as called for
by GAAP. Also, securitized receivables are excluded from operating cash flow and are reported as a
component of external financing, a line item referred to as receivables-related financing on the cash
flow analysis statement. Adjustments such as these were deemed necessary to get a clearer picture of
a company’s sustainable cashgenerating ability