A Comparables Approach To Measuring Cash-Flow-At-Risk (c-far) For Non-Financial Firms

01 August 2000
By Louis Guth and Dr. Michael Tennican, et al.

In this article, we present the results of our efforts to develop a measure of cash-flow-at-risk (c-far) for non-financial firms. c-far is the probability distribution of a company's operating cashflows over some horizon in the future, conditional on information available today.

For example, if it is December 31, 2000, a company's quarter-ahead c-far refers to the probability distribution of operating cashflows over the quarter ending on March 31, 2001; year-ahead c-far refers to the probability distribution of cashflows over the year ending on December 31, 2001. These probability distributions can be used to generate a variety of summary statistics, such as five-percent or one-percent "worst-case" outcomes, as in: "how much can my company's operating cashflow decline over the next year in a five-percent tail event?"

While it is easy to define the concept of c-far, it is much more difficult to come up with a reliable c-far estimate for any given company. One way to see the challenges associated with constructing a c-far measure is to compare it with the value-at-risk (VaR) measure that is commonly used by banks and other financial institutions. Although there are some obvious differences between the two, c-far focuses on cashflows while VaR focuses on asset values; c-far looks out over a horizon of a quarter or a year (while the horizon for VaR is typically measured in days or weeks); it is, nevertheless, clear that c-far is an attempt to create an analog to VaR that can be useful to non-financial firms.

In this paper, we describe how we have implemented this sort of top-down, comparable-based approach to c-far measurement. As we will explain in detail below, we use a relatively sophisticated benchmarking technique to find the best comparables for a given target company, searching for those other companies in the universe that most closely resemble our target on four dimensions: 1) market capitalization; 2) profitability; 3) industry riskiness; and 4) stock-price volatility.