Traditional cash flow |
| Posted by: Sandy Jul 28 2004, 11:24 AM |
| When calculating traditional cash flow for a Sub Chapter S Corp, wouldn’t you have to calculate a global cash flow including all business and personal income & business & personal debt as the business income is passed through to personal income? |
| Posted by: loanuniverse Jul 28 2004, 12:46 PM |
| Not necessarily… In fact most times loans to small businesses are structured with the owner/principal as guarantor, and the goal of the analysis is to find out if the business entity can repay the proposed debt. In the most usual of cases, you would then take a look at the personal cash flow of the owner/principal as a secondary source. Most times this secondary source will be negatively affected by the fact that it relies mostly on the business entity that is your borrower. Other times, the owner/principal has other substantial sources of income and financial strength that enhance the credit. I am not saying that you shouldn’t look at a global cash flow. In fact, a lot of banks do look at this number when dealing with small businesses. However, I think is best to look at the borrowing entity alone and see if it can repay the debt without having to rely on additional sources. I guess the opposite argument would be to say that not looking at the personal debt service might underestimate the amount of debt that has to be repaid from the personal cash flow, but this can be easily addressed in the “guarantor comments” of the analysis and even brought up as a weakness of the credit. Enough rambling, in essence you can do it either way, but I personally prefer to separate both. |
| Posted by: Sandy Jul 29 2004, 10:16 AM |
| Ok, so if you do a separate personal cash flow of the owner/principal, would you include the business debts because the income used to pay the business debts is what is passed through to personal income? Also, another scenerio: Loan to a new company, so repayment is coming from personal income of owner/principal/guarantor. This income is derived from several sources including several S Corps and/or partnerships. Again, since these business’s income is passed through to the personal income and this income is used to pay the debts of these businesses, would you include in the personal cash flow analysis, the debts of these businesses? |
| Posted by: loanuniverse Jul 29 2004, 01:06 PM |
| ”Ok, so if you do a separate personal cash flow of the owner/principal, would you include the business debts because the income used to pay the business debts is what is passed through to personal income?” If my loan is to Joe’s Widget Co., the cash flow analysis for the company will include the debt service for all debt out to Joe’s Widget Co. On the other hand, the personal cash flow for Joe will only include the wages paid by Joe’s Widget Co. to Joe, and any withdrawals that Joe might have taken out of the Company. I would try to stay away from recognizing the pass through income as cash flow, because it isn’t really cash taken out. It is just accounting income. Lets use a hypothetical company called Joe’s Holdings that is a real estate holding vehicle for an office building. Lets say that this company is shown as providing $5,000 of income in schedule E, but if you don’t know that Joe’s Holdings had depreciation of $15,000 during that year, you are undercounting the cash flow by at least that amount. You also don’t know if Joe’s Holdings had CPLTD of $20,000 during that year essentially wiping out all of its cash flow. ”Loan to a new company, so repayment is coming from personal income of owner/principal/guarantor. This income is derived from several sources including several S Corps and/or partnerships. Again, since these business’s income is passed through to the personal income and this income is used to pay the debts of these businesses, would you include in the personal cash flow analysis, the debts of these businesses?” The best way to do this would be to get copies of the K-1 schedules from the 1120S and find out how much money was taken out in distributions always looking at this from an angle of “likelihood of recurrence”. Sometimes this is a problem because not all of the K-1s are available. You will also have the lenders complaining that you are penalizing the borrower a lot if he does not take distributions, but is showing considerable earnings. This brings me to the second best way to analyze this and is taking into account the net income from all of these companies, which can be found on schedule E. The problem with using this combined “income” is that income is not cash flow. You are coming from the right angle by mentioning that the debts of these businesses has to be repaid by the cash flow, but you really can’t figure out what the combined cash flow is from the 1040. You would need at least the tax returns for each of the companies involved. I am not saying this is not done. I am just pointing out the weaknesses. If I had enough financial information in each of the businesses, I would do a traditional cash flow analysis on each and then use the combined cash flow. Not the income. Then I would add the cash flows to get a combined cash flow from closely held companies {make sure to adjust for percentage of ownership in each} and use that number as a component of the personal cash flow. I know that this would be the long way to go about it, but it is common sense and a defendable position if you get asked for a reason. |
