The first startling discovery was that working capital and the current ratio routinely understate liquidity because there is an account missing from the balance sheet: the Current Portion of Fixed Assets (CPFA). The breakthrough concept of CPFA was first published in the America’s premier accounting journal and subsequently expanded in a two-part series in America’s leading banking journal
This 12 minute video illustrates graphically the compelling logic of the Current Portion of Fixed Assets and how it resolves the paradox of negative working capital.
Negative working capital is a false indicator of illiquidity due to a flaw in how we calculate it: the Current Portion of Long-Term Debt (CPLTD) is not repaid from “current assets” but from the use of fixed assets. This article illustrates how AT&T pays its creditors despite a $5-billion-dollar negative working capital by using its fixed assets. One way to correct the calculation of working capital is to include the Current Portion of Fixed Assets (CPFA) in current assets to offset CPLTD in current liabilities.
This sequel illustrates the alternative solution for correcting the calculation of working capital: remove CPLTD from the formula. The result is a new concept: Trading Capital, which reveals that there are two tiers of liquidity—Trading Capital and Working Capital—that together provide greater analytical insight into a company’s true liquidity than was possible before.
Here is the complete framework for viewing cash flow in terms of natural, recurring cycles that led to discoveries such as the Current Portion of Fixed Assets and the stratification between Fixed Capital, Trading Capital, and Working Capital.
The analysis of liquidity risk and loan repayment is significantly enhanced by measuring the sustainability of cash flow cycles with new, precise primary coverage ratios and cross-cycle ratios. Ultimately, theory finds practical application by identifying cash flow problems and crafting appropriate remedies.
Maintenance Capex is an important use of cash that must be included in cash flow analysis. However, it must be analyzed within its natural balance sheet cash flow cycle. M-Capex is an investment cash flow that must be matched with its natural financing cash flows. Deducting all of M-Capex from operating cash flow overstates the deduction which can lead to missed lending opportunities and even lost clients.
Today’s linear analysis of cash flow focuses on operating cash flow. That may be useful for security analysts, but for SME lenders, the loans we make are financing cash flows, which are used to acquire assets—investment cash flows. This article reexamines the importance of balance sheet cash flows, which are largely overlooked because they are missing from—netted out of—the Statement of Cash Flows.
Stephen M. Bartoletti
Small and Medium Enterprises (SMEs)
are at the heart of economic development and job creation.
Small and Medium Enterprises
are also at the heart of commercial bank lending and leasing.
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