Predicting a Firm's Financial Distress: The Merrill Lynch Co. Statement of Cash Flows
(3 pages of text)
During the night of September 14, 2008, a few hours before Lehman Brothers folded, Merrill Lynch declared defeat: it was acquired by Bank of America (BofA). Unsure of its ability to continue as a standalone entity, Merrill Lynch ended 90 years of independence. Before its buyout by BofA, Merrill Lynch was the world’s largest and most widely recognized stockbroker. It dominated retail stockbroking with its army of 16,000 brokers around the world. At the start of 2008, Merrill Lynch, Goldman Sachs, Morgan Stanley, Lehman Brothers, and Bear Stearns were the five largest standalone investment banks, with a combined total history of 549 years. But within a span of six months, they would all be gone as independent investment banks. Some observers wondered whether any early signs of the financial distress that the investment firm industry experienced in 2008 could be seen in the financial statements published in the years preceding the acquisition of Merrill Lynch. In addition, was there merit in evaluating the performance of the company from an angle other than that of operating results, which is typically used by financial analysts? Specifically, would there be value in an assessment of the company’s performance by scrutinizing the origin and use of its liquid assets for the years 2005, 2006, and 2007? Such an investigation would require focus on the statements of cash flows, including the need to:
- Evaluate the cash situation at year-end.
- Analyze cash flows provided (used) by operating activities.
- Analyze cash flows provided (used) by investment activities.
- Analyze cash flows provided (used) by financing activities.
The numerous bankruptcies and financial difficulties experienced by American banks and several financial institutions in 2008, a phenomenon that had been unseen in analysts’ forecasts, point to shortcomings in existing financial analysis techniques. A key question is the following: What is the informative value of the statement of cash flows in predicting the financial distress of a company? This case is intended for MBA or undergraduate students (future managers, investors, and auditors) to make sense of cash flow statements and look at companies’ performance beyond statements of earnings. The aim of this case is to enhance the informative value of cash flows by doing a thorough analysis of the statements of cash flows disclosed in the three years preceding the 2008 financial crisis by Merrill Lynch & Co.
Finance and Insurance
United States, Large, 2008
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