Global Cash Flow and the Small Business Loan

Recently, I was part of a bank wide project that reviewed a large sample of the commercial loans in our portfolio. Included in the sample were a few dozen small business loans. The project allowed me to get more acquainted with the subject of Global Cash Flow.

As the manager of a Middle Market { Companies with sales between $20 Million and $1 Billion per year } underwriting team, I instruct my analysts to underwrite the loans to the borrowing entity’s ability to repay. Our procedures require that we look at the cash flow generated from the business as the primary source of repayment. We only look at the personal cash flow of the owner as the secondary source of repayment, and only when the owner provides a personal guarantee. In other words, the business has to stand on its own.

In the world of Small Businesses things are a little different. The line between the owner and the business is blurred in many occasions. It is not uncommon for the owner to use the money from the business for personal expenses as well as using the personal cash flow to keep a business going. Furthermore, a lot of the business owners extract all of the cash flow produced from the business, and others hold a job with a different employer providing an additional source of cash. In fact, many of the small businesses would not qualify for a business loan if their applications were underwritten solely on their ability to repay.

What is Global Cash Flow?

In the context of Small Business Lending, Global Cash Flow is the sum of the personal owner/guarantor recurring income, and the cash flow from the business.

Why look at the Global Cash Flow?

The idea behind the use of the Global Cash Flow is that in the case of Small Businesses looking at the business alone does not provide the whole story. The cash flow available to service debt from the Small Business might be too little to repay a proposed loan, but the reason might be that the business owner takes most of the money out in the form of salary or distributions. Looking at the business and the owner together gives a complete picture.

Isn’t the money taken out by the owner used for personal expenses?

Of course, and that is why adding up the income is just part of the underwriting exercise. The lender has to take into consideration that some of that money that the owner takes out will be used for living expenses as well as to repay personal debt. Normally, the way this is handled is to:

a)      Deduct estimated personal expenses from the personal cash flow.

b)      Account for all personal debt repayment {Auto loans, mortgages, credit cards, installment loans…. etc.}

Will the information about the personal cash flow and personal expenses be available to the lender?

It should be if the lender is requesting what they should be requesting. The underwriter can get a lot of the information from the personal tax return, the personal financial statement, and the credit report. There will be a need to estimate something like living expenses, but that is not hard to do and most lenders just use a set percentage of recurring income with a minimum amount built in {floor}.

What good is it to know the Global Cash Flow?

The Global Cash Flow on its own is not very useful. What is useful is to find out if the sum of the personal cash after living expenses and the business cash flow is sufficient to repay the business debt as well as the personal debt. If you follow the simple mathematical instructions below, you will get a Global Debt Service Coverage Ratio. This number should be at least 1.00X, or cash would be deemed insufficient. Most bank lending policies require a minimum of 1.25X.

 

Personal Cash After Expenses
+ Business Cash Flow
= Global Cash Flow (GCF)
Personal Debt Service
+ Business Debt Service
= Global Debt Service
Global Cash Flow / Global Debt Service = Global Debt Service Coverage

 Anything else I should know?

There are many things that can go wrong when calculating Global Cash Flow. These are a few mistakes that I have noticed through the years:

  • Double counting distributions. If you are adding distributions to the personal cash flow, remember that they need to be deducted from the business cash flow.
  • Relying on one time non-recurring income.
  • Forgetting to take into account other business income. Sometimes, the owner/guarantor has more than one business. To be a truly global calculation, the underwriter must take all of the business ventures into account.
  • Not adjusting for reasonable living expenses. This includes expenses for all of the dependents of the individual

 

You can learn more about the subject of cash flow and business loans by buying the following books at Amazon: Small Business Cash Flow: Strategies for Making Your Business a Financial Success

or

The SBA Loan Book: The Complete Guide to Getting Financial Help Through the Small Business Administration

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