Calculating Income on Self-Employed

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Calculating Income on Self-Employed
Posted by: Robert Apr 13 2004, 10:59 AM

I’m starting to get involved into small to medium size commercial loans. My primary focus over the past several years has been in residential lending. My concern is being able to extract the necessary items used in calculating income on self-employed borrowers total income from their corporate tax returns. In order for me to obtain as much information as possible in order to maximize my borrowers income. What are some of the specific items that can be added back to income such as depreciation, expense and others that can be used.

My potential borrower has an S-Corporation and (2) Limited Liability Corporations. Although the information being extracted from the tax returns are probably one of the same. I want to make sure I am not leaving anything out in calculation of my client’s total income.

Is there any information, software or books I can obtain that will help me improve my knowledge in this area finance. Please advise any information I can obtain to help my client. I’m just want to continue extending the best level of service to my commercial clients, as I have my residential customers.

Thanks for your help and guidance.

Posted by: loanuniverse Apr 13 2004, 12:02 PM


When talking about underwriting commercial loans, the individual is looked at as a backup source of repayment. In the case of an operating company, the primary source of repayment will be either conversion of trade assets or the cash flow from operations of the company. In the case of a real estate holding company, we look at the net operating income after operating expenses are deducted from the rental income. If you are talking commercial loans, you are talking company or project specific underwriting. If you have to rely on the individual behind the company or project for repayment that would be seen by someone like me as a bit of a deficiency. Not necessarily bad enough to kill the request, but in my mind it does not make much sense to get into a business investment that can not pay its funding.

When we look at the individual behind the company, we look at the cash flow not the income. You are in the right direction when you mention the adding back of the depreciation expense, but doing a proper personal cash flow analysis takes a very detailed approach to the tax return. The analyst pretty much dissects the tax return and goes over it line by line. The process can vary in its detail. I have worked for banks that had half a dozen guidelines as to what to add and deduct, but I have also worked for banks that have six pages of instructions as to how to account for every line.

From your post, I see that this borrower has three companies. The way that most lenders approach closely held entity’s income is to disregard it. Even if the income is pass through such as it is the case on S Corps. and LLCs. Remember that we are looking at cash flows and not income. Therefore, we concentrate on the schedule K-1s and look for the amount of distributions from these entities. That is where the cash flow from those companies is reflected.

Frankly, the whole personal cash flow analysis is too detailed, but I can point you in the direction of one of the best resources. There is a company called Omega Performance that provides training material for commercial bankers. I believe the Company is now part of Moody’s Analytics. The courses might be on the expensive side, but they are the ones that I learned from when I graduated in the 90s.

Good luck and hope this helps.
Author: Commercial Loan Underwriter