As a basic proposition, however, the bank as a creditor defines a healthy
cash flow as one in which net cash inflow from the normal operations of
the firm is sufficient to cover both financing payments and the mainten-
ance of the quality and efficiency of its assets. Depending on where the
firm is in its business life cycle, the bank would also like to see some per-
centage of the growth in assets (increasing working investment and gross
plant expenditure) covered by internally generated funds.
Analysis of cash flow concentrates, then, on the debt servicing ability of
the firm. By isolating, in a firms cash flow, an amount of cash available
for debt servicing, however, it is important to remember that:
this is not an identifiable pool of cash earmarked solely for debt ser-
vicing, and
from the corporation’s point of view there may be a number of other
needs equally urgent and necessary to ensure solvency of the business
that are competing for the limited cash available.
Analysis of cash flow, then, cannot merely isolate debt capacity but must
also consider all the factors producing major changes in cash inflows
and outflows. The primary hazard of too much debt compared to cash
generated is the risk of insolvency, and debt servicing is given top prior-
ity as far as the bank is concerned. However, all decisions involving cash
outflows vital to the survival of the firm need to be considered when
evaluating cash solvency.
What are the uses of cash flow
Cash flow forecasting is subject to several types of risks. It is useful,
therefore, to look at these risks by category and identify their salient
features and characteristics.
Credit worthiness – a company’s financial condition can be analysed
and tested under various scenarios to assess and enhance the intrinsic
credit worthiness
Cash Flow Forecasting
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Project feasibility – a project can be tested using various assumptions
in order to establish whether or not the project is feasible, and what
measures can be adopted to enhance the project’s feasibility
Loan structuring – specific weaknesses in the credit can be identified,
thereby enabling the loan facility to be optimally structured in terms
of amount, tenor, pricing
Financial covenanting – specific financial covenants can be created
and tailored to the borrowers financial condition
Security perfection – specific shortfalls can be identified and the
resulting credit risk enhanced via the perfection of security arrange-
ments, including assets and guarantees
Loan document drafting – financial projections can be used to iden-
tify the parameters of specific issues and problems, which can
subsequently be managed via the appropriate drafting of loan
Overview of cash flow forecasting
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