The Rise and Fall of Kodak

Kodak dominated mass-market consumer photography for over a century. But it failed to meet the challenge from digital photography and went bankrupt a year ago. How could a company as strong as Kodak fail so badly? This post explains what happened to Kodak. In our next post we’ll explain why it happened in terms of an important risk dynamic we call the “Incumbent’s...

A Swing Line for Swingline

In November 2011, ACCO Brands, a leading manufacturer of office products, and MeadWestvaco Corporation, a leader in packaging, agreed to merge MeadWestvaco’s Consumer & Office Products business into ACCO Brands in a transaction valued at approximately $860 million. The deal, which closed in May 2012, gave MeadWestvaco shareholders 50.5% of the combined company.  Among the company’s many products are Kensington computer accessories, Mead school supplies, and Swingline Staplers. As part of the transaction, ACCO refinanced virtually all of its existing debt.  The new capital structure included $500 million of high yield bonds and over $750 million of term loans.  In addition, the company obtained two revolving credit facilities: $200 million U.S. dollar, and $50 million multi-currency. Let’s take a look at the $200 million U.S. dollar revolver.  It has commitments from 16 banks, ranging from about $4 million to about $20 million (i.e. 2% to 10% of the total facility) and was expected to be used for general liquidity needs and letters of credit.  If the company has a financing need, say $100 million for 6 months, it sends a borrowing notice to the administrative agent, in this case Barclays, who sends a notice to the other 15 banks, who all advance their proportionate share of the total borrowing.  This process happens for hundreds of syndicated revolvers every day. But what if the borrowing need isn’t $100 million for 6 months, and is, instead, $10 million for 6 days?  The process could work the same as for the larger, longer need, but that would mean that the bank with the smallest commitment, in this case Deutsche Bank, would have...

What’s That Burning at Tesla?

We blogged about Tesla just over a year ago, looking at what we called the company’s “liquidity burn.” We thought they only had about a year’s worth of liquidity left. Since then, burning through liquidity hasn’t been Tesla’s biggest problem. Instead, Tesla’s troubles have been with burning cars. Three of its sleek Model S cars have caught fire recently, and that may hurt sales or force a recall. Can Tesla afford it? A slowdown in sales or a recall would hurt cash flow, which has been improving lately. Free cash flow was $25.8 million dollars in the third quarter this year, driven by the success of the Model S. If cash flow falters, Tesla’s next line of defense will be its liquidity reserves, which also have grown a lot in 2013. Tesla used to keep about $200 million in liquidity in the form of cash and short-term investments. But in May 2013 the company raised $660 million in the convertible bond market and $617 million in the equity markets, using $452 million to repay its loans from the U.S. government and $178 million to hedge the convertible bonds. Tesla used the remaining $647 million to recharge its liquidity reserves. At the end of September 2013, they stood at $795 million. Is that enough? The size of a liquidity reserve should be based on the company’s ability to generate free cash flow and its vulnerability to event risk. Event risk is the unexpected need for cash caused by natural disasters, accidents, and product recalls. The cost to Toyota for its 2009 recall of 8.1 million cars for faulty break pedals was...

99 Cents Only Stores goes Lite

99 Cents Only Stores operates a chain of over 300 “extreme value retail stores” in California, Texas, Arizona and Nevada.The company was founded in 1982, and in January 2012 it was taken private by Los Angeles private equity firm Ares Management and the Canada Pension Plan Investment Board.  The new capital structure was typical of LBOs done at that time: Size (millions) % of Capitalization EBITDA Multiple(b) Revolver(a) $10 Term Loan $525 Total 1st lien debt $535 38% 3.4x Senior Notes $250 18% 1.6x Total Debt $785 55% 5.0x New Equity $536 Rollover Equity $100 Total Equity $636 45% 4.0x Total Capitalization $1,421 100% 9.0x (a) The Revolver commitment was $175 million, of which only $10 was borrowed at the time of the transaction (b) Using fiscal year 2012 pro-forma adjusted EBITDA, a reported by the company The company’s choice of loan products shows that one of its objectives was to maintain as much operating and financial flexibility as possible: The revolver is an Asset Based Lending (“ABL”) facility.  Compared to most secured “cash flow” revolvers, ABL facilities typically have fewer and less restrictive covenants.  In fact, it is common for ABL facilities to have no financial covenants, or to have financial covenants that are only measured if the company borrows most of what is available under the borrowing base.  This additional flexibility is a key advantage for ABL borrowers. The term facility is a Term Loan B (“TLB”).  This provides the company with significant cash flow flexibility.  It has amortization of only $5.25 million per year (i.e. 1% of the original principal) and a final maturity of 7...

Where are we at Suntech?

Suntech isn’t who we think it is The company known as Suntech isn’t simply Suntech at all. It’s a group of 41 different holding companies, intermediate holding companies, and operating subsidiaries tied together by common ownership. Suntech Power Holdings Company Ltd., based in the Cayman Islands, is the parent company, the ultimate owner, directly or indirectly, of all the others. Wuxi Suntech Power Company Ltd., in the Peoples Republic of China, controls the most important operating subsidiaries. Each company in the Suntech group is a separate legal entity with its own assets and liabilities. Suntech Power Holdings’ biggest assets are its shares of three intermediate holding companies; its biggest liability is $585 million in debt held by U.S. investors and the World Bank. Wuxi Suntech’s subsidiaries own most of the plant, equipment, and inventory and generate nearly all of the cash flow; its biggest liability is $1.7 billion in debt held by Chinese banks. Structural subordination Suntech’s legal complexity is more than just an opportunity for lawyers; it’s also a problem for Suntech Power Holdings’ bondholders. Even though their bonds are senior under the terms of their own indentures, they are junior to Wuxi Suntech’s bank loans. That’s because of something called structural subordination. Structural subordination occurs when a holding company borrows money at the same time as an operating subsidiary does. Suntech Power Holdings relied on cash from Wuxi Suntech for debt service, but Wuxi Suntech had its own debt payments to make to the banks. By forcing Wuxi Suntech into bankruptcy, the banks blocked payments from Wuxi Suntech to Suntech Power Holdings and to the bondholders. Mount...

Outage at Suntech

Here comes the sun In 2008, the clouds of pollution that clot the skies over China’s cities had officials there gasping for relief. They were even more troubled by the slowdown in China’s economy. Their solution was to promote solar energy, not only for clean energy production but also for exports and jobs. The government backed the solar panel industry with massive lending programs from state-controlled banks. China’s solar module manufacturing capacity grew from less than 5 gigawatts in 2007 to just under 40 gigawatts in 2011, more than double the total in the rest of the world, and far in excess of demand. The market for solar modules was only 5 gigawatts in China and 30 gigawatts globally. The result was a collapse in panel prices worldwide. Suntech’s power fails For Suntech, China’s largest solar panel maker, prices fell from $3.72 per watt in 2007 to $1.51 per watt in 2011. In terms of volume, Suntech’s sales were strong, with sales in megawatts of generating power up 34% in 2011. But low prices coupled with above-market, take-or-pay supply contracts for raw materials short-circuited profits. Adjusted for special charges like asset impairments, operating profits were negative in 2011 and the first quarter of 2012. Suntech’s free cash flow was negative in most years because of heavy investments in working capital and in plant and equipment. The company was able to offset operating losses with working capital efficiencies, and cash flow from operating activities went from ($30) million in 2010 to $93 million in 2011. But capital spending proved harder to cut; it actually increased from $276 million in 2010...

Office Depot is buying OfficeMax for $1.2 billion. Why?

Competition Office supply retailing has been a tough business lately. Demand for paper, writing materials, envelopes, and many other products is falling as people do more and more work on line. On-line stores are making big inroads, just as they have done in books, music, and consumer electronics in the U.S. and the U.K. mass merchants are also selling more and more office products. It’s a fiercely competitive industry, with intense rivalry, demanding buyers, growing substitutes, and aggressive new entrants. Even the biggest competitor, Staples, can only manage a paltry 0.44% return on equity. It seems foolish to commit any more capital to an industry with so little potential for profit. Competitive position But the deal makes sense just because things are so grim in office supplies. It’s bad enough to be buffeted by the forces of a hyper-competitive industry, but it’s much worse to be facing such challenges from a weak competitive position. Office Depot and OfficeMax are among the industry’s top three competitors. Office Depot has about 19% of the office supply market and OfficeMax has 16%, while Staples has 30%. Amazon, W.B. Mason, WalMart, Costco, and the other competitors have the rest. Size matters. Companies with large market shares are generally more profitable than companies with smaller shares. They benefit from bigger economies of scale in production, marketing, distribution, and financing. They enjoy greater experience curve efficiencies, more bargaining power with customers and suppliers, and an advantage in attracting and retaining good managers. But it’s not absolute size or ranking among the leaders that matters, it’s relative size – how much bigger or smaller a company...

5 New Year’s Resolutions for Credit Analysts

1) I will think like an equity analyst.  In order to properly assess the credit risk of a company, you must understand what management is thinking.  Since management works for the owners of the company, not its creditors, you must think like an owner.  Is there a viable business plan?  What is the company’s competitive advantage?  What is the company’s plan for growth?  How will the company enhance returns to shareholders? You must understand the pressures management is facing.  Is the share price dropping?  You can bet that management will do something to push it up, like a share buyback, special dividend, divestiture, or acquisition (or even worse, they will “manage” earnings).  Is the owner (whether a private equity shop or a family) interested in selling the company?  Perhaps they will defer capital projects (or, once again, “manage” earnings). 2) I will think like a debt analyst.  OK, you must understand the owner’s perspective, but you must also keep in mind that what is good for the owner is not always good for creditors.  For example, shareholders love high growth companies – they get higher equity valuations (and their managers often get higher compensation).  But high growth often means high risk and, perhaps, low or negative cash flow.  Remember, a business plan can be good and appropriate for the company, and at the same time, high risk from a credit perspective. 3) I will avoid elevator analysis.  No one needs you to tell them if sales (or margins or leverage) went up or down.  People can see that themselves by looking at the numbers.  Your job is describe why the...

Risk Culture in Action

Risk culture is the way people behave about risk. But people, organizations, and risk are all complex and dynamic. It’s important to have a formal concept of risk culture, but perhaps the best way to explain it is through examples. Dan Sparks at Goldman Sachs In 2006, Dan Sparks was the partner in charge of mortgage trading at Goldman Sachs, and by mid-year he was troubled by growing risks in the mortgage markets. For the next six months he tried to escalate his concerns. In Sparks’ words: ”It was tough…and I mean tough…the rigor that Goldman Sachs puts on people is unbelievable…especially when there’s a concern…I went up there to the 30th floor…five times…’We’ve got a problem…Here’s what’s going on. Here’s what I don’t understand. Here’s what I’m worried about.’ As soon as you do that…they get the risk controllers and all kinds of people involved…I mean they’re all over it.” In December David Viniar, Chief Financial Officer, convened a meeting to discuss Sparks’ views. The decision was to “get smaller, reduce risks, and get closer to home.” As a result, Goldman ultimately gained $4 billion from hedging its mortgage exposures. For more on risk management at Goldman read Money and Power by William D. Cohan. Madelyn Antoncic at Lehman Brothers Madelyn Antoncic was Chief Risk Officer at Lehman Brothers from 2005 to 2007. Before joining Lehman, she’d been a mortgage trader at Goldman Sachs, head of market risk at Goldman Sachs, and head of market risk at Barclays. In 2005 she was Risk Magazine’s risk manager of the year, and in 2006 she was named one of the...

So What Exactly Is Risk Culture?

Consider the sad story of UBS. In 2007 it suffered $38 billion in losses on mortgage back securities, requiring a $60 billion capital infusion from the Swiss government to keep from going under. In 2008 it paid out $19 billion to clients it had duped into buying worthless auction-rate securities. In 2009 it had to pay the U.S. government a $781 million fine for helping wealthy Americans evade taxes. In 2011 it took $2.3 billion in losses on a $12 billion trading position built up without authorization by one trader, who hid it by booking fictitious hedges. This is more than a series of unfortunate incidents. It’s a pattern that points to terrible problems with risk and controls at one of the world’s largest and (formerly) most prestigious financial institutions. How could things go so wrong for so long at UBS? Critics were quick to attack the firm’s risk culture: “At UBS, It’s the Culture That’s Rogue” by James B. Stewart and “Questions Arise About UBS Risk Controls” by Alistair MacDonald and Deborah Ball. Even the company acknowledged it had to improve its risk culture: “UBS 2007 Annual Report (page 10).” And the problem ran deep. “The problem isn’t the culture,” one investment banker said, “The problem is that there wasn’t any culture. There are silos. Everyone is separate…People cut their own deals, and it’s every man for himself…People thought of themselves first, and then maybe the bank, if they thought about it at all.” Too deep for management to fix. Sergio Ermotti, the CEO brought in to fix risk at UBS after the 2011 trading crisis, has decided...

How Long Before Tesla Runs Out of Juice?

Tesla Motors has drawn a lot of attention for its sleek, high-performing electric cars. Its Roadster has been an enviro-celebrity favorite for several years, and its new Model S sedan is getting great reviews. The company has been trying to scale up to large-scale production since 2009, raising $226 million in the stock market and $465 million in Department of Energy loans. But there are growing concerns that Tesla might run out of cash before it can get into full production. The original plan for the Model S was to produce 5,000 in 2012, but the company recently cut that to 3,000. At that level of production, how long will it be until Tesla uses up its sources of liquidity? Over the last four quarters, Tesla’s internal cash flow deficit was $423 million. That was mainly the result of heavy start-up costs, which caused a $159 million shortfall in cash from operating activities, and from capital spending of $412 million. Unusually, cash flow from working capital was positive. Tesla has hardly any accounts receivable; instead, it charges customers a $5,000 deposit on each car they order. Customer deposits contributed $100 million dollars to cash flow through the last four quarters. How has the company recharged its cash batteries? From two sources: cash reserves and loans. Tesla has drawn $109 million from cash reserves and $298 million from the Department of Energy since June 2011. That left Tesla with $211 million in cash at the end of June 2012. As we noted in an earlier post about Kodak, “cash burn” is commonly defined as “the rate a company uses up...

My Favorite Bank Ethics Story

The Background: I was a vice president at a global bank, responsible for a diverse group of clients in North America.  One of my clients was considering a major reorganization of its business and restructuring of its balance sheet, and it hired my bank as financial advisor.  Since we were a lender to client and a restructuring could have impacted our position, the bank saw the conflict and (with the consent of the client) set up separate teams.  Given the size of the assignment and the large potential fees, the advisory team was led by the bank’s Vice Chairman, and included the head of my department, who was my boss.  My “team” (really just me and an associate) was responsible for the bank’s balance sheet – our counterparty risk and our lending position, including a large syndicated loan for which we were the agent. The Setup: The advisory assignment went on for several months, during which I could not discuss the client with my boss or anyone else on the advisory team.  This led to some strange situations, like running into people from my bank in the elevator at the client’s headquarters (a very silent ride), or sitting across the table from them in client meetings. Finally, key elements of the restructuring began to emerge.  To make it work, one large asset of the client had to be quickly and quietly sold.  This is when my boss called me into his office and gave me the term sheet showing our bank buying the asset.  But, since he was on the advisory team, he couldn’t buy it.  It was up...

Decaffeinating Green Mountain

Last October, David Einhorn, head of Greenlight Capital, a hedge fund famous for taking short positions in Lehman Brothers’ shares before Lehman failed, attacked Green Mountain Coffee Roasters’ in a presentation at an investors’ conference. It was a tour-de-force of financial analysis. Using only publicly available information, Einhorn made a strong case for unrealistic sales growth and overstated earnings. Since then, things have only gotten worse for Green Mountain. The share price collapsed. Robert Stiller, the founder, was forced to sell shares to meet margin calls on $617 million in personal debt secured by his Green Mountain shares and had to resign the company’s chairmanship. The SEC continued with an investigation into the lack of disclosures about a key distributor. And many of David Einhorn’s concerns remain. We’ve looked at one of the issues he raised: capitalizing operating costs. Here’s our own analysis, updated with the latest fiscal year data. As Green Mountain reports it, sales have been growing at an striking rate, propelled by demand for its K-Cup coffee brewers and pods and by acquisitions. After a dip in 2010, Green Mountain’s EBITDA margins expanded along with sales, peaking at nearly 18% in the fiscal year ending in September 2011. One tactic companies use to understate expenses is to capitalize them. That is, they add current period operating costs to property, plant, and equipment — or some other asset with a life of more than a year — instead of treating them as cost of goods sold or selling, general, and administrative expenses. That spreads them out over a number of reporting periods as part of depreciation expense...

A Perfect Storm

The shipping industry is in rough waters lately. In many categories, global capacity exceeds demand, and shipping rates and ship values have sunk to near-abyssal lows. Take the VLCC (“very large capacity carrier”) tanker business, for example. Back in 2005 and 2006, shipping companies had every reason to be optimistic about potential demand. Asian economies were booming, and their need for oil was surging. So they ordered scores of large, new vessels. Between 2007 and 2011, the world’s VLCC fleet grew by 10%, but demand for oil grew by only 3%. With capacity that far ahead of demand, shipping rates plunged to near-record depths. Reduced income from ships meant reduced values for ships, and vessel prices fell by 55% over the same period. The industry got caught in a perfect storm of business cycle and industry cycle risk. The business cycle drove down demand for shipping when the United States and Europe went into recession in 2008 and 2009 and emerging economies slowed down. But even after the global economy recovered in 2010 and 2011, shipping remained trapped in a classic industry cycle. Industry cycles occur when capacity exceeds normal, recovery-stage levels of demand. Prices plummet, and revenues fall with them. Industry cycles are different from business cycles. In business cycles revenues are demand-driven; in industry cycles they are price-driven. There is more at work in industry cycles than the simple microeconomics of supply and demand. They have a complex set of drivers. They are most common in industries with these characteristics: commodity products or services; large economies of scale; high fixed costs; intense competition. Commodity industries are especially...

How Much Can I Borrow on My Revolver?

We often tell our clients that a company does not file for bankruptcy on a particular day because it has too much leverage, or because it has a bad management team, or because it has a competitive disadvantage.  All of these factors may eventually drive a company out of business, but the reason a company files for bankruptcy on a particular day is liquidity: they run out of cash.  Therefore, it is important to measure a company’s liquidity as part of any comprehensive financial analysis (one of our favorite tools is the liquidity position). For many companies, availability under a committed, revolving line of credit is a key source of liquidity. Here’s an example: In 2010, Sears Canada entered into a five-year $800 million senior secured revolving credit facility.  As of January 28, 2012, they had borrowed $101 million under that facility.  How much additional can they borrow using that revolver? a) $699 million b) zero c) Something between $699 and zero The answer is … you don’t have enough information to give an answer.  According to Sears, they have $415 million available. Here are the factors that determine how much you can borrow on a revolver: How much you have already borrowed.  In the Sears example, it would reduce availability to $699 million Letter of Credit usage.  Many revolvers can also be used for letters of credit.  This allows companies to issue letters of credit without getting credit approval for each one individually.  However, letters of credit issued under a revolver reduce borrowing availability under that revolver.  In the Sears example, they had approximately $284 million of letters...

Developing Problems at Kodak

Kodak’s cash burn was a big concern among analysts in the last months before the firm’s bankruptcy in January of this year. Cash burn is a term that gets thrown around a lot when companies are in trouble, but it’s hard to find a definition for it in books on accounting or financial statement analysis. Accountingglossary.net defines cash burn as “the rate that a company uses up cash” and calculates it as “Total Cash Change / Time Period.” We think that’s a useful approach to analyzing how a company consumes its cash, although we think we have a better way. Our method starts with the company’s Internal Cash Flow. To calculate Internal Cash Flow, start with the company’s cash flow statement and use the values presented there. The formula is: Internal Cash Flow = Cash Flow from Operating Activities + Cash Flow from Investing Activities + All Uses of Cash in Financing Activities. Cash flows with negative values in the cash flow statement have negative values in the formula. Uses of cash in financing activities include debt repayment, dividends, share repurchases, and any other outflow in that part of the cash flow statement. Internal Cash Flow includes all operating and investing sources of cash and all operating, investing, and financing uses of cash. It’s cash flow before external financing, so it excludes cash from borrowings, debt issues, and equity issues. If Internal Cash Flow is negative, the company is not generating enough cash in the period to meet all of its needs. That leaves it with only two ways to plug the cash gap: get financing or use cash...

There’s Your Sign

At a lunch meeting in July 2011 to go over his concerns about massive, unexplained fees linked to Olympus’ acquisition of Gyrus in 2008, Michael Woodford, the new President and CEO, got the first sign his job was in danger. Chairman Tsuyoshi Kikukawa and Group President Hisashi Mori were served an elegant assortment of sushi; Woodford got a tuna sandwich. In October, Woodford was fired before he could press his inquiry any further. Since then, Olympus has been forced to take a $1.3 billion loss and see its credit rating fall two notches to BBB+. Kikukawa and Mori have lost their jobs and been arrested. The tuna sandwich was Woodford’s own early warning, but how could an outside analyst have seen Olympus’ problems developing? We’ve blogged about the early warning signs of companies in distress before: Early Warning Signs at Borders Part 1 and Part 2. We think Olympus is a good example of our sixth sign, problems with management. Olympus is a classic example of a recurring problem with management at troubled companies: desperate strategies. From 2008 on, as smart phones with built-in cameras grew in popularity, the company’s sales of digital cameras suffered and profits collapsed. And digital cameras were vitally important to Olympus, accounting for as much as 26% of sales but only 8% of operating profits in 2008. What was management’s response? Unable to counter the threat from telephone cameras, Olympus made a string of senseless acquisitions, including companies in pet care, medical-waste disposal, microwave cookware, and mail order cosmetics. When it made an acquisition in a core business, Gyrus in medical equipment, it overpaid....

Risk Culture at MF Global?

By the time they grew to $1.5 billion, Michael Roseman, MF Global’s Chief Risk Officer, was concerned about the firm’s positions in bonds of Italy, Spain, Portugal, Ireland and Belgium. He was worried the trade might endanger the entire firm if the financial problems in Europe got too tough. Roseman believed MF Global didn’t have enough liquidity to withstand a credit rating downgrade. Roseman joined MF Global in 2008 to improve risk-management culture after a rogue trading incident cost the firm $140 million. As the Euro sovereign positions grew to $6 billion, they blew through trading limits that he had helped put in place before John Corzine, MF Global’s new CEO, became his boss. It was Roseman’s job to get the directors to approve any increases in those trading limits. He made at least three separate requests to increase sovereign debt exposure. Each time, directors asked him about the risks of the trade. And each time, in spite of the fact it challenged the CEO’s pet strategy, he did what he was supposed to do: he outlined the risks as he saw them. But Corzine insisted on maintaining the trade, even threatening to resign if the board did not back him. So Roseman was replaced, and a new risk officer, Michael Stockman, took over in March 2011. But he was not allowed to weigh in on the broader implications of the sovereign debt trades, including the risk of ratings downgrades, loss of investor confidence, and funding problems. Which, of course, is exactly what happened. By October, MF Global had succumbed to a liquidity squeeze and filed for bankruptcy. This...

Counterparty Risk Trips Up MF Global

The New York Times DealBook blog just put out a fine piece on the collapse of MF Global: A Romance with Risk That Brought on a Panic by Azam Ahmed, Ben Protess, and Susanne Craig (December 11, 2012). It’s the most comprehensive summary of the events that led to the firm’s bankruptcy that we’ve seen so far. Until the investigations are done and the books are written, it’s a good source for thinking about the credit risk lessons to be learned in MF Global’s sad story. MF Global seems to have made a lot of risk management mistakes. It took on a big dose of market risk with its $6.3 billion exposure to the European debt crisis – over the objections of its senior risk manager. With only $1.4 billion in capital, the company could barely afford to take any losses. There may have been operational risk issues at the firm as well. About $1.2 billion of client money has gone missing, and after weeks of searching the company’s records it’s still not clear where most of it is. At best, this is a serious systems failure; at worst, it could be a lot more sinister. But the fatal risk at MF global was a form of credit risk called counterparty risk. That’s the risk that a firm involved in a trade fails to pay what it owes. Counterparty risk is where market risk and credit risk intersect: as a company’s trading losses grow, its ability to pay decreases. Moody’s downgraded MF global from Baa2 to Baa3 in October, citing exposure to European sovereign debt, a regulatory capital shortfall,...

Why Are Covenants So Bad?

We’ve been running a poll on the Comments on Credit blog for the past few months asking 2 questions: It is no surprise that bankers like the debt service coverage and fixed charge coverage ratios best – they are good measures of a company’s ability to pay its financial obligations as they come due (without relying on external financing).  We think they are the best ratios to measure a company’s liquidity (much better than the current and quick ratios, but that is a topic for another post). If debt service coverage and fixed charge are the best measures of coverage (and liquidity), the real question is why we don’t use them more often in covenants?  The most used coverage covenant (in our survey and in our experience) is EBITDA coverage. Accuracy vs. Simplicity Whenever we look at ratios, for analytical purposes or for covenants, there are always the conflicting goals of accuracy and simplicity.  We could write a ratio that looks at a company’s internally generated cash flow (say, free cash flow) relative to all of its future, normalized financial and operating cash outflows, but by the time we write the definition into a credit agreement it would be too long and cumbersome.  As it is, we’ve see fixed charge coverage definitions that exceed one full page of (very small) text.  And even then, there may be disagreements between borrower and lender about how it should be calculated. So, in order to make the numbers easy to calculate and avoid disputes in the future, we sometimes go with simpler covenants, even if they are not the best measures of a company’s...