Emerging Practices for Capital Adequacy © Copyright 2003, CCRO. All rights reserved. 51 The simplest, and probably the most acceptable, way to determine expected cash flow from operations is to use the statement of cash flows as the base case and construct a forward-looking statement of cash flows (a procedure that some companies use in their planning processes) or by modeling specific activities that generate or use cash (e.g., modeling specific revenue generating operations or forecasting the cash needs of specific expenses and investments). 8.2.3 Backup Credit Facilities There are several forms of credit facilities, and the relative strength of each must be evaluated. For example, a lending agreement whereby a lender is contractually obligated to provide backup financing is a very strong one, whereas a non-contractual agreement, such as a line of credit, is relatively weak because the lender has the right to refuse to provide funds. An example of a weak backup credit source is a backup funding agreement that contains a “material adverse change clause” whereby a bank has the right to refuse funding if the bank believes the borrower’s financial and/or operating conditions have substantially deteriorated since the agreement was initiated. To be consistent with the nature of liquidity, the sources of liquidity include only financial resources that can be readily converted to cash in a short time. Thus, market financings such as shelf capacity or asset sales would normally not be included because of the potential negative impact on operations from sales and for external funding, there are funding uncertainties associated with the company’s financial and credit situation during a forward period. Further, not all companies have the same capital structure for funding or financing obligations over a short-term or long-term horizon. Given that companies have different capital structures in place, the following information may provide additional insight into a company’s liquidity: • Expected cash flow from operations (CFO) • Cash flow from investing/financing activities • Sources of liquidity for funding operations over a one-year period • Maturity schedule of revolvers, credit facilities, and debt obligations • Secured and unsecured collateral • Expected asset dispositions • Long-term funding sources • Constraints on funding • Parent/subsidiary guarantee of obligations.18 8.3 Fixed Payments Fixed payments are the liquidity obligations associated with investing or financing activities under normal day-to-day operations that are not included in cash flow from operations. This includes, but is not limited to, fixed charges such as debt principal, dividends, debt/equity retirement, and the current portion of committed, maintenance, and non-discretionary capital expenditures. 18 If the guarantee from the parent can be quantified as a degree of subsidiary credit enhancement, its impact needs to be included in the estimation of the capital adequacy of the subsidiary.