The document summarizes the financial distress of Merrill Lynch leading up to 2008. It provides an overview of the company and timeline of key events. An analysis of Merrill Lynch's cash flow statements from 2005-2007 shows deterioration, with cash from operations declining significantly. While cash and financing activities were increasing, this was due to asset sales and debt raises, not underlying business performance. The declining cash flow from operations and increasing debt were early signs of financial distress that analysts failed to properly identify by not adequately analyzing cash flow statements.

1. Predicting a Firm's Financial
Distress: The Merrill Lynch Case
Group C
Aagam Parikh 2021PGP190
Aniket Gawande 2021PGP197
Krishnapriya Nair 2021PGP210
Mayuri Mundada 2021PGP213
Namrata Singh 2021PGP218
Surya Nayak 2021PGP241
Y Abhideep 2021PGP251

2. Company Overview
In April 2008, the CEO stated,
“Merrill Lynch has produced excellent,
even some record-breaking results, and we
suffered the worst performance in the
history, and reported $8.6 billion net loss
from continuing operations.”
 Founded in 1914, and became a publicly-
traded company on June 23, 1971
 Leading global trader and underwriter of
securities and derivatives across the broad
range of asset classes
 Served as a strategic advisor to corporations,
governments, institutions and individuals
worldwide
 World’s largest and most widely recognized
stockbroker, it had an army of 16,000 brokers
around the world with 40 offices
CEO John A. Thain
Post the 2008 financial crisis, the company’s CEO had
revised his words stating in an interview –
“ The Company’s position is strong in liquidity, and the
company would not seek more outside capital to support
the balance sheet. We lost $8.6 billion last year, but against
this we raised $12.8 billion in under two months and more
than the losses we suffered. ”
BUSINESS RISKS
o Market Risk
o Credit Risk
o Commodity Risk
o Liquidity Risk
o International Risk
o Operational Risk
o Litigation Risk
o Regulatory Risk

3. TIMELINE OF MAJOR
EVENTS FOR MERRILL
LYNCH FROM 1999-2009
Merrill agrees to be
acquired by Bank of
America at $29/share in
September
Credit Losses reach
$40 billion. Merrill
scrambles to raise
capital and sell
risky assets
O’Neal ousted as
mortgage losses
begin to mount.
John Thain
appointed as new
head
Largest
underwriter for
stocks and bonds
for the last time
Approval of
federal reserve
and shareholders
Stanley O’Neal
appointed chief
executive who later
becomes chairman
Adds billions of
dollars of
mortgages to
balance sheet.
Acquires First
Franklin Financial
Corp, a subprime
lender
1999 2002
2006
2007
2008
2008
2008
2009
Treasury
Department
injects $10
billion of TARP
money
originally set
aside for Merrill
Lynch

4. Analyst and Executive views
 At the beginning of 2008, Merrill Lynch, Morgan Stanley,
Lehman Brother, Bear Stearns and Goldman Sachs, were
leading largest standalone investment banks
 During the financial crisis of 2008, they all suffered huge
losses and had to sell off existing businesses
 Early signs of financial distress suffered by Merrill Lynch
could have been seen in the financial statements
published earlier
 Even though the company’s CFO had been stating “We’re
very, very comfortable with balance sheet that we have
and, more importantly, the credit quality that’s on the
balance sheet. The company has $44 billion in equity
capital”, there are tools and techniques to approach and
to identify the financial distress of the company.
Situation during 2008 crisis What the analysts said
Citi Bank analyst gave a BUY rating with a $45 price target
with an optimistic earning power which could double up
over the next two years given that the worst was behind.
Moody gave a credit rating of A2 which is the sixth highest
credit rating
S&P had a negative outlook on the bank with a price target
of $25
Goldman Sachs gave a SELL recommendation
These recommendations came at the back of disposal of risky
assets, employee cuts, raising of new capital and with the
thought of the worst period being over. Even the most
established houses could not predict what was coming ahead

5. Evaluation of Cash Situation
 The company’s cash situation is very unpredictable
 Despite these increases the company also incurred income
taxes and interest expense with same rate.
 Situation is going to only go downhill, because the company has
generated 47% less cash (from $17,523 mn to $9,237 mn) as
compared to the year 2006, and it is also predicted that cash or
equivalents will continue to decline, due market conditions.
Therefore, steady 3 years deterioration of cash is indication of
financial distress.
Particulars 2007 2006 2005
Cash and Cash Equivalents, beginning of
period
32,109 14,586 20,790
Increase / Decrease in cash & cash
equivalents
9,237 17,523 -6,204
Cash and Cash Equivalents, end of period 41,346 32,109 14,586
 Additionally, the company’s debt to equity ratio increased
from 11.5 (2006) to 17.3 (2007) without a substantial increase
in generation of cash and cash equivalents. This raised serious
doubts on company’s ability to repay it’s debts. The return on
assets also decreased considerably from 1.2% (2006) to -1.1%
(2007).
 The cash position of the firm has increased in the last 3 years
mainly due to disposal of assets and financing activities,
giving the impression that the firm was well capitalized.
 Further analysis of the cashflow statement will prove this
level of cash was not enough to support the heavy losses
and subsequent write-downs incurred by the operating side
of the businesses.
 The company cannot finance negative growth and the
losses from operating activities can’t exceed cash flows
from financing in the long-term.

6. Cash Flow from Operating Activities
 The company’s cash flow from operating activities is in the
state of decline from 2005 to 2007. This is a clear sign that
the company is not operating effectively for few years before
the crisis hit in 2008.
 At first the cash flow went down only by 2.1% (from 2005 to
2006), however, the situation became worse in 2007, when
the cash flow from operating activities reduced by 204%
(from 2006 to 2007).
 Derivative contracts have increased by 49%, which is
extremely risky for the company in such circumstances,
indicating the company’s poor working capital management.
 23.2 billion of the 86.9 billion in changes were attributable to
CDO write-downs or exposure to the US subprime mortgage
market. The CEO noted that he expects additional write
downs in the future, which will continue to significantly
impact future operating cash flows.
 There is a high difference between cash flow from operations
and net income. This shows poor efficiency for the company

7. Cash Flow from Investing Activities
 Company’s investing activity also does not give a
positive outlook of the activity. Although a growing
company’s investing activity is sometimes negative,
which indicates the company has invested in fixed assets,
and will generate the cash flow, there are chances that
the company has a negative cash flow from the
investing activities due to the poor assets-purchasing
decisions.
 The overall proceeds from discontinued operations are
positive in 2007. These are one-time events and could
indicate the business is shedding assets.
 The company’s sales of available security for sale is
giving a positive cash flow, the purchases made against
it is not supporting the investing activity, due to poor
assets-purchasing decision of such securities. This may
influence and increase the debt needed by the company.
Additionally, the company’s investing activities are
carried disproportionately which led to negative cash
flow.

8. Cash Flow from Financing Activities
 From a simple analysis of the direction of the net cash
flows from financing activities that cash is on the rise,
but this does not necessarily indicate the company is
on solid financial grounds.
 The firm used the majority of this borrowed cash to
pay off their existing debt in the market.
 In issuing of new debt, the firm has significantly
increased their total debt to equity ratio which is a red
flag for long term insolvency.
 Not only is debt mounting, but the company is
becoming increasing incapable of generating returns
on the equity that they are financing. The returns on
equity has gone down from 19% (2006) to -25% (2007).

9. Conclusion
 One most important financial statements, cash flow, was ignored during the analysis, by most financial analyst.
 In the case of Merrill Lynch, the statement of cash flow should be seen as it gives clear view on how effectively company is
generating cash from its operations, even if the investing activity may give negative number due to investment in fixed assets.
 Post analyzing the situation, we believe that the analysts could have predicted the impending financial distress that the company
was suffering quite early on had the cash flow been analyzed properly.
Thank you