Cashflow Analysis

EBITDA is NOT cash flow

EBITDA is used in commonly used ratios such as DSC (EBITDA/CPLTD) and leverage (debt/EBITDA), but it does not capture key items such as interest, taxes, working capital and capital expenditures that affect a company’s cash flow
EBITDA – Taxes – Increase in NWC – Capex – Other operating investments = Free Cash flow available for debt service
To calculate DSC,
- Make adjustments to current cash + expected incoming + expected outgoing
- Expected outgoing expenses (how elastic are these expenses. Non- discretionary and inelastic)
- Equity injection (personal equity) – See promoters’ track records in terms of how willing he is to fund

PD Analysis: EBITDA =/= CASHFLOW

Adjustments to Financial Statements

Moody’s adjustments to financial statements

Defined benefit pensions
Operating leases (off-BS, only lease expense on P/L)
Finance leases
Capitalised interest
Capitalised development cost –> MOST IMPORTANT
Capex
Planned
– Maintenance (hard to reduce, depends on elasticity)
– Incremental (may be reduced)
Committed
– Timing
– Financial Consequences (break cost)
3 sources of finding out planned and committed capex
– Regulatory requirement for management disclosure
– Analysts own estimates (Eg. taxi companies need to replace after 10 years)
– Ask customer (RM’s call report)
Interest expense related to discounted LT liabilities other than debt
Hybrid securities
Securitisation
Inventory on a LIFO cost basis
Consistent measurement of funds from operations – different measures of working capital
Unusual and non-recurring items
Unusually large transactions (creating revenue, costs or cash flows) that management does not expect to recur in the foreseeable future
Other analytical non-standard adjustments

** DETERMINE IF THESE ADJUSTMENTS ARE MATERIAL RELATIVE TO EQUITY BUFFER
Why equity buffer? Because it affects D/E ratio which can change the credit rating

Dividends – In Cash VS Shares

The “Ideal” Balance Sheet

Cash conversion on the asset side is exactly matched with repayment cycle on the liabilities side
Current ratio is not useful because it ignores maturity mismatches within the 1 year bucket
Some current assets may have to move down the pyramid
- Eg. Obsolete Inventory, Imparied AR, etc
- Even cash is not always immediately available (eg. cash in different currency or location or units)
Long term liabilities may come due immediately
- If a ST trade creditor sue, other loans may come due immediately
- Covenant and credit events
- Bullet repayment

What is the adjusted equity buffer?

Overvalued assets (involving non-market valuation)
- Intangibles (e.g. brands or goodwill)
- Inventory (e.g. biological assets)
- Land and properties (less of a concern in SG)
Accounts receivables
- RP balances vs. RP transactions (elasticity)
- Island debtors
- Types of concentration risks
Irretrievable assets (T&C risk)

Contingent liabilities/ hidden liabilities à more likely to crystallize at declining stage
- Warranty obligations or anticipated litigation loss
- Environmental/ third party claims, e.g. kampong head
- Labour union claims under negotiation
- Operating leases
Liabilities disguised as equity: substance over form, when is the repayment date?
- Perpetual preference stocks
- Strategic vs. financial investors (e.g. SME – “friend’s investment”)
Pension obligations (increase discount rate for NPV calculation)