Skip to Content
Stock Strategist

Firms at Risk for a Shortfall

Morningstar's Cash Flow CushionTM can be used to identify refinancing and liquidity risk.

Mentioned: , , , , , , , , ,

The recent financial crisis has underscored the propensity of credit markets to be unpredictable and cost-prohibitive. When assessing a firm's overall financial health, especially firms with weak credit, we think it is important to be able to identify future periods when cash shortfalls and debt refinancing risk are likely to occur. In fact, the very nature of the credit markets at the time when a company may have to refinance debt or shore up liquidity can have profound implications on its likelihood of default as well as on the value of its equity. This is especially true if the firm has no choice but to refinance at materially higher costs, or issue new stock at bargain-basement prices to retire maturing debt.

The Cash Flow CushionTM used in the calculation of Morningstar's corporate credit rating is a measure that takes a firm's excess cash on hand plus adjusted free cash flow generation over the next five years, and divides that sum by the firm's cash contractual commitments over the same time horizon. This measure provides investors with an intermediate-term view of the firm's future path of cash inflows and outflows. It also helps investors to determine if a company's future cash generation will be sufficient to meet its debt-like cash obligations, in aggregate, over a five year period.

To view this article, become a Morningstar Basic member.

Register for Free

Brian Nelson does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.