Board Topic: Difference between CPLTD and Notes Payable
Click here to view this topic in its original format
LoanUniverse Community > General Chat >

Difference between CPLTD and Notes Payable

Posted by: TMH Apr 29 2004, 01:04 PM
What is the main difference between CPLTD and Notes payable, particularly as it relates to retirement of debt and debt service coverage?

Thanks,


TMH

Posted by: loanuniverse Apr 29 2004, 05:55 PM
TMH:

What is the main difference between CPLTD and Notes payable, particularly as it relates to retirement of debt and debt service coverage?

Being that analyzing a company for a loan has to do with the operational cash flow, the debt service for the proposed facility is projected using both CPLTD and notes payable. Of course, the number of years that the lender is going to project into the future will depend on the maturity of the proposed loan.

CPLTD stands for "Current Portion of Long Term Debt", and it reflects the amount of principal that is due within the next twelve-months. To make it easy to understand, lets say that on 12/31/03 the company gets a $600,000 loan to purchase a big piece of equipment payable in monthly installments of $10,000 plus accrued interest.

The balance sheet dated 12/31/03 should reflect the following entries in the liabilities:

CPLTD = $120,000

Long-Term Debt = $480,000


If I am looking at this from the point of view of a new loan, I know that this company has to have enough cash flow to pay those $120,000 that will be going out during 2004, as well as the interest for that loan, and the debt service for the loan in process.

Notes Payable on the other hand, is a bit more complicated. Mostly because of the usual bad quality of some company prepared or even compiled statements. This is the reason why it is important to know what those notes payables are really about and find out what kind of an amortization they are under. It would not surprise me if a prospective borrower will put the whole amount as a non-current liability. This would be wrong, and needs to be adjusted when calculating the debt service coverage.

On the other hand, if "notes payable" is under current liabilities, the best way to handle them would be to add them as par of the debt service for the next year.

These concerns are usually mute when dealing with audited financial statements, as the CPA usually includes a note indicating the future maturities of long term debt. As a commercial credit analyst, I can use that information to project far into the future without having to ask the company's management to elaborate on the numbers.

Hope this helps.

Posted by: TMH Apr 29 2004, 10:50 PM
I appreciate the prompt reply. Just to give you some background, I am a credit analyst with a strong financial background (capital budgeting, WACC , etc) and a not strong enough accounting backgorund; the accounting stuff is new to me (particularly tax information) and I am still learning on the fly. I did not know what the main differencec was between notes payable and current portion of long term debt and apparently there isn't really one except by how the borrower/accountant classifies the debt.

I work in a small bank in a department which processes small commercial loans. Because the majority of our loans are for small businesses, we stress a global cash flow (includes the personal income and expenses of the borrower/guarantor), particularly for deals under $250M. I would like your opinion on our DSC coverage formula and your opinion on using a global DSC rather than using strictly a business DSC.

Our global DSC is as follows:

The Sum of NCAO (from a UCA Cash Flow Model) + a portion of the guarantors wages (NOT AGI because AGI often includes business income and double counting is of course a No No) divided by the sum of notes payable of the business, CPLTD of the business (this is why I asked you about the difference between the two), interest expense of the business, annualized guarantor's expenses (mortgage payments, installment loan payments, retirement of a percentage of the revolving debt) and the proposed new debt (annualized payments if it is a term loan or if it is a line a percentage retirement of the max of the line plus the interest expense if the line was maxed). What is your opinion of this? Do you think this tells the full story or are there other factors we are not considering? I know for most people this site is a resource on how to obtain financing or gain information on the financial world and this may not be the right site to post a question such as this, but it seems as if you are an unbiased source of information and I would really like your honest opinion on this model and how we could possibly improve upon it.

I am also interested if there is any section on loanuniverse dedicated to the artistic and subjective nature of lending and particularly underwriting. Other factors come into play completely unrelated to cash flow, or finances for that matter, that can definitively change an analyst's opinion, particularly if something is borderline. For example, a new real estate loan for a 3 flat with three long time (2 yrs+ for example) tenants and a proven real estate investor as the borrower is much more appealing than a new RE loan for an investor who has no RE investing experience and is looking to buy a building with no tenants, even if the potential cash flow is the same. I have seen a lot of things on the site in regards to quantification and formulas (which are very important as my above comments would suggest), but not much as to the subjectivity of analysis and lending.

Formulas are the main thing, but they aren't the only thing.

I eagerly await your comments and I really do think you do an excellent job with the site.

Regards,

TMH

Posted by: loanuniverse Apr 30 2004, 01:07 AM
I appreciate the prompt reply. Just to give you some background, I am a credit analyst…. Well it is nice to have you visit. Normally, I get mostly financial professionals that work on the dark side of the force {lending officers}.

I did not know what the main difference was between notes payable and current portion of long term debt and apparently there isn't really one except by how the borrower/accountant classifies the debt. Remember that when you are spreading the financials you get to move things around that do not make sense. If for example the business was not reflecting any CPLTD or short-term notes payable, and showed substantial long-term debt as a non-current liability titled “notes payable” you might want to find out what portion is due within the next twelve months and move it to current. Jumping ahead a bit to the Global Cash Flow model that your employer uses. I assume that the only “notes payable” that are added to the denominator are the ones that are current. If you guys are adding all of the “notes payable”, you might be penalizing the borrower too much.

I would like your opinion on our DSC coverage formula and your opinion on using a global DSC rather than using strictly a business DSC. Maybe it is because most of the deals that I work on are for middle market companies {my employer defines middle market as companies with revenues of $5MM to $50MM}. Maybe it is because I don’t deal with small businesses that much anymore, but to be honest, the idea of using a Global DSC does not appeal to me.

I understand where you guys are coming from. At the small business level it is hard to make a line and decide where the business ends and where the individual starts. I also know that at that level, the bank is putting a lot of emphasis on the individual, which is the way it should be, but I would prefer to take a look at the borrowing entity apart from the owner. To tell you the truth for loans where the business cash flow is not enough, I have used the old standby of “primary source of repayment will be the cash flow from operations of the borrower supplemented by the personal income of Mr. So and So”, but I am of the idea that the business has to be able to repay the loan alone.

Regarding the formula, I got a couple of comments and a couple of questions.

What number are you looking for 1.20X?

How do you account for the owner’s living expenses?

Do you only take into account the guarantor’s wages? How about other sources of income? Is taking into account only a portion of the guarantor’s wages done so that living expenses are taken out? Do you use tiers for the amount of money that is allocated to living expenses? {for example a guarantor making $40,000 might need $20,000 for living expenses, but one making $100,000 might need $40,000}

Why do you take a percentage of the line of credit {not an amortizing facility} and add it to the denominator? If you are providing short-term working capital for receivables or inventory your primary source of repayment is conversion of assets. Cash flow is secondary. I have never seen people do that for lines of credit.

What percentage of the revolving debt do you add to the denominator? I have used 3% monthly, which is 36% annually.

This might betray my ignorance of small business underwriting, but consistently relying on the guarantor does not seem like a sound practice. You are essentially making all those loans “guarantor dependent loans”. Who regulates your employer the OCC or the OTS? Having worked for institutions regulated by both, I have found the OCC to be much tougher regulators to please. Have the regulators ever commented on this practice?

How about your loan review? Is it in-house or do you outsource it? Have they commented on this practice?

You know something…. I don’t see personal tax liability anywhere. I think that combining both the business and personal cash flow without accounting for the personal taxes might get messy in S-Corps where the company reported a lot of taxable earnings. Then again, I haven’t actually done any of these so I might be wrong. Just writing my first thoughts.

Thinking back as to how I have done it when using the guarantor’s personal cash flow as an addition to the borrower’s operational cash flow. I have performed a cash flow analysis using the personal tax return and looked for excess cash to add back.

I am also interested if there is any section on loanuniverse dedicated to the artistic and subjective nature of lending and particularly underwriting. The name loanuniverse is a bit too ambitious, I picked it back in 1998 because I thought it sounded nice. However, the site is not really that big. There are only about 250 pages in the site some of them dating back to the beginning. Frankly some of them are not really that good in terms of content, but I keep them around although now I could probably explain things much better.

While I have expressed my opinions on particular deals, there is no single way to look at a deal when dealing with the request subjectively. Only doing several deals of the same type and sticking around the bank a couple of years to see which one went bad and why can give you the tools to assess the subjective part of risk.

There is a reason why our job cannot be fully replaced by credit scoring software. It takes a human being to detect the subtle things out of the ordinary. The reason why I don’t talk about subjective elements is that I never have all of the information that is needed to make a subjective call on a deal as it is presented in this site. Somebody will show up looking for feedback on a loan for its business, but I don’t have his resume in front of me, I don’t have the receivables in front of me, I sometimes do not even know the industry that they are in. It is hard to give subjective feedback, and I hesitate to say something like “that is doable”, when I do not know if it really is doable. I would hate it if the visitor then goes to the bank, gets turned down flat and either thinks that the lender is no good or that I do not know what I am saying.

Talking numbers is much easier smile.gif

Posted by: TMH Apr 30 2004, 08:21 AM
Interesting. Again, I appreciate the prompt reply.

I assume that the only “notes payable” that are added to the denominator are the ones that are current.

Correct. Everything is based on the cash flow for the next year, so factoring in notes payable should just account for notes payable within the next fiscal year; to me this seems to be the same as CPLTD, so I'm curious as to why my company separates it out on our DSC. You are also very correct that when spreading the financials you have to put numbers where they belong, and not where the borrower thinks they should be.

At the small business level it is hard to make a line and decide where the business ends and where the individual starts.


Exactly. The business and the individual (in small businesses) are intertwined and it is very hard to differentiate between the two.

To tell you the truth for loans where the business cash flow is not enough, I have used the old standby of “primary source of repayment will be the cash flow from operations of the borrower supplemented by the personal income of Mr. So and So”, but I am of the idea that the business has to be able to repay the loan alone.

The only problem with this, in my opinion, is that the owner of the business is often taking a lot of cash out of the business for personal expenses and you have to consider those as directly detrimental to the business. If the guy takes the cash out, but does not spend it (maintains high bank balances and limited debt on his credit report) then it is ok. But if he draws a lot from the business and has huge expenses (mortgage and car payments, etc) then the operation of the business could be directly affected because the business does not have a lot of cash to fund operations and that, in my opinion, is poor management. If he has huge expenses and still has plenty of money for the business to service debt, then the business is doing pretty well.

What number are you looking for 1.20X?

Correct.

How do you account for the owner’s living expenses?

We only take a portion (50%) of the wages as available for debt servicee. The other 50% is assumed to be eaten up in taxes and living expenses, etc. We do make adjustments for people with higher income levels on a case by case basis as the situation merits. Again, the subjectivity comes into play.

Do you only take into account the guarantor’s wages? How about other sources of income? Is taking into account only a portion of the guarantor’s wages done so that living expenses are taken out? Do you use tiers for the amount of money that is allocated to living expenses?

I should not have said that we alone consider his wages. That is somewhat incorrect. We do consider other forms of income (rental property income, SSI, etc) and add that as his available personal income to service debt. We just do not include any type of profit from business operations (of the business applying for the loan--if he has other businesses we will add the income from these back in) because it is already included in NCAO. We do not use tiers; as I previously stated, this is where the subjectivity comes into play. I know the standard is 38% of cash should go to living expenses (taxes, incidentals, etc.), but for the sake of conservatism, we generally stick with 50% for living expenses and 50% available to service debt.

Why do you take a percentage of the line of credit {not an amortizing facility} and add it to the denominator

We assume a partial retirement (20%) of the line because the line does balloon in one year and we expect some of it to be repaid. Again, this is also subjective and conservative, but it does mitigate risk and improves the qualitites of the credits we approve. It is also a condition that the line be debt free for 30 consecutive days and unless they do that in the first month (which it is my experience that most people don't) some sort of principal paydown will occurr during the term of the line.

What percentage of the revolving debt do you add to the denominator?

33% annually.

How about your loan review? Is it in-house or do you outsource it? Have they commented on this practice?

Honestly, I do not know much about loan review, so I can't comment on this. Sorry.

You know something…. I don’t see personal tax liability anywhere.

It is counted as part of the living expenses of the guarantor.


I appreciate your comments in regards to the subjectivity and also look forward to hearing your responses on the above listed comments.

Regards,

TMH


Posted by: loanuniverse Apr 30 2004, 06:01 PM
You know, you make a good argument for using this “global cash flow”. It does seem like the formula is well thought out and takes into consideration possible variations. The funny thing is that I was talking to a fellow analyst today and I told him how you guys used the “global cash-flow” and he told me about this deal he had on his desk, that had a loan on the books that was analyzed a couple of years ago. {Let’s just say that this deal comes from a less sophisticated area of the bank when it comes to commercial lending}. The thing is that this deal was done using a variation of global cash flow. I asked him to read me the formula that they used, and we soon realized that they failed to account for the guarantor’s personal debt service. I am glad that you guys seem to have done your homework.

I am going to play devil’s advocate and find something to nitpick. You know the way that the credit manager sometimes goes over your analysis and feels that he needs to do changes that you might not agree with, but he does them anyway because he feels like he has to find something to criticize.

When you said: ”if he has other businesses we will add the income from these back in” Income is not cash flow. If you are taking into account the income that is shown on the first page of the personal tax return from other businesses even after you deduct the borrowing entity’s income, then you are accounting for taxable income that might not be available. The true cash flow will be shown as a withdrawal in the K-1 schedule, which is in the 1120. I know that most times it is not available, but accounting for the income… hmmm I do not know how accurate that would be.

We assume a partial retirement (20%) of the line because the line does balloon in one year and we expect some of it to be repaid. Again, this is also subjective and conservative, but it does mitigate risk and improves the qualities of the credits we approve. It is good to be conservative, but why 20%? I mean why not 30% or 15%. It is just not common to see a portion of a line of credit included.

It is also a condition that the line be debt free for 30 consecutive days and unless they do that in the first month (which it is my experience that most people don't) some sort of principal paydown will occur during the term of the line. Ahhh cleanup… I am so glad most of my lines do not have that. I don’t have to go to the history anymore and get all of my info from the first screen.

I think your global cash flow is fine just not my cup of tea. Then again, I am not a credit policy officer so when in Rome do as the Romans.

Posted by: twalker915 May 1 2004, 06:17 AM
Interesting discussion on cash flow.

How do you two treat the calculation of capital and leverage ratios when dealing with accelerated depreciation? If my LLC has $300,000 in 'book' capital but accumulated unbooked accelerated depreciation of $150,000 (scheduled on my tax returns), what do you consider my capital to be?

Do you have a different measurement for diffferent ratios? Let's say my loan covenants require a $200,000 minimum capital level, am I in violation? Let's say I have a maximum 3:1 debt to equity limitation and I have $600,000 in debt, am I in violation?

I appreciate your thoughts, or better yet, any real guidelines that exist governing this issue.

thx............tim

Posted by: loanuniverse May 1 2004, 08:44 AM
Twalker:

Here is my feedback

How do you two treat the calculation of capital and leverage ratios when dealing with accelerated depreciation? If my LLC has $300,000 in 'book' capital but accumulated unbooked accelerated depreciation of $150,000 (scheduled on my tax returns), what do you consider my capital to be? If there are different numbers of net worth in the corporate financials and the corporate tax returns most of the time you will go with the corporate financials.

This is actually more common than people think. The only thing that I might want to take a look at is to see if the corporate financials are accounting for deferred tax liability, which arises because the net value of the assets in the books is actually higher than the value at which you are carrying the same assets in the tax return. If you were to sell those assets at $300,000 you would have to pay taxes on the $150,000 that you have depreciated already.

Let's say my loan covenants require a $200,000 minimum capital level, am I in violation? Let's say I have a maximum 3:1 debt to equity limitation and I have $600,000 in debt, am I in violation? The easy answer is no! You will be in violation at $600,001 debt or if your net worth decreased to $199,999. The right answer is “it depends” as in how exactly is the covenant written. Is it debt to net worth? Or debt to tangible net worth?

any real guidelines that exist governing this issue. A 3.00X debt to net worth used to be the standard for the lender that I used to work for a couple of years ago {back when I used to do more small business loans}. Going back in time to the bank before that, I think we also used a similar ratio. On the other hand, other lenders emphasize tangible net worth so that is much more strict. Furthermore, there might no be written guidelines on leverage, but it is approached on a case by case basis.

Good luck

Posted by: twalker915 May 1 2004, 11:27 AM
Thanks for your response. Please give me your definition of Net Worth vs Tangible Net Worth.

I have a client (an LLC) that has $450,000 in 'book' capital or net worth. But, there is a total of $460,000 in accelerated depreciation that has never been booked.

The loan covenants read "Tangible Net Worth".


thx................tim

Posted by: loanuniverse May 1 2004, 12:15 PM
Tangible net worth is the net worth minus intangible assets. However, in credit analysis we deduct a little more.

First, we deduct intangible assets such as goodwill, organizational costs and capitalized loan costs. Then we take out those assets that are owed to the company by the owner or related companies. All too often, the borrower will have an entry such as "notes payable from stockholder" in the assets. Frankly, I could turn around and say that I owe my company a million dollars and then claim that my company is worth a million dollars, but it really isn't.

...I have a client (an LLC) that has $450,000 in 'book' capital or net worth. But, there is a total of $460,000 in accelerated depreciation that has never been booked.... Has this client reported any depreciation at all on his corporate financials?

If you are not running your financials on a tax basis then you must reflect somewhere this deferred tax liability. Granted the entity is an LLC and it is pass through, but then there must be a note in the owner's personal financials. On the other hand, as long as there is some depreciation shown in his financials even if it is straight-line most analysts will not pick this up when doing the analysis.

Posted by: twalker915 May 1 2004, 01:04 PM
Yes, they are showing substantial 'straight line' depreciation on the books.

We are in the process of changing banks. So far, none of the new bankers have brought this up. It is only a million dollar credit so it won't get a lot of attention. I am not comfortable with the way it has been handled but I am looking for a good answer to the analysts when (if) they realize the situation. I do not want my clients to sign a loan agreement and then be declared immediately in default because of technical insolvency.

Again, I appreciate your response.........tim
email

Comments are closed.