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This note uses the Uniform Credit Analysis (UCA) Cash Flow Statement to explore the purpose(s) of a firm's short-term debt. Employing a fictional firm, we examine whether the firm's short-term borrowing is entirely intended to fund the firm's net current assets. The results suggest a financing mismatch in the firm's use of short-term debt in all three years of the study period, either to help fund the firm's investment in capital (long-term) assets or to cover the firm's current portion of long-term debt. This analysis provides a useful technique for lending institutions to discern whether potential or existing commercial customers are using short-term debt for a purpose(s) other than supporting net current assets.
INTRODUCTION
Recent research by Beach et al. (2017) compares the FASB 95 and Uniform Credit Analysis (UCA) cash flow statements and discusses the benefits of the UCA format. Noting that the FASB 95 statement is static in nature whereas the UCA statement is more dynamic in focus, the authors argue that the UCA format is a superior tool for commercial credit analysis.
One issue on which the UCA statement of cash flows can offer additional insight relates to the purpose(s) of a firm's short-term debt. Specifically, is the firm's short-term debt solely intended to fund the firm's net current assets? Or is the firm increasing its risk profile by using short-term borrowing to pay the current portion of long-term debt and/or to fund, at least in part, capital (long term) assets? These questions are important to creditors for determining the purpose of any loan request or advances on an existing Revolving Line of Credit (RLOC), as well as to investors when assessing a firm's risk exposure.
In this regard, it is worth noting that a basic commercial loan underwriting principle is to match the term of a loan with the life and cash flow of the pledged asset. This lending technique (sometimes known as short-to-short and long-to-long) is crucial for the sustained health of a growing company. Short-Term Notes Payable on a firm's balance sheet are typically advances against a RLOC to support net current assets. Such advances are commonly secured by eligible accounts receivable and inventory and based on a firm's unused borrowing capacity. A company can potentially experience liquidity...