Global Cash Flow – A Hot Button Issue

11/23/2011

By Daniel R. McDonald

As a loan reviewer, or one who enthusiastically examines a bank’s loan portfolio, I am often asked what the “hot button issues” are. These can vary depending upon where one might be, the current economic times, the examining body overseeing a bank. However, one item seems to pop up more often than others. This item is, unfortunately, often overlooked, but is easily the most important - global cash flow. Global cash flow is a calculation that can greatly impact the repayment of your loan, but its intricacies are often disregarded or misunderstood.

Cash is king and the vast majority of credit presentations we examine illustrate this front and center. Lenders will discuss why their borrower’s cash available can service the proposed debt and prospects for future repayment are as rosy as can be. This is where the road diverges. Some lenders play the role of detective and ferret out all debt, while some lenders walk blindly, only focused on the debt at hand. These are the lenders who fall short in their duty to the bank and the customer. Being able to repay your loan is wonderful; however, not all borrowers bank at one institution. If the balance sheet shows more debt than your loan and it is not accounted for in the presentation, the true debt service may be one of those mysteries unknown to all.

Most banks would prefer going into a transaction as an omnipotent being, knowing more about the customer’s finances than perhaps even the customer. Never lend without peering behind every door – it could lead to an unpleasant encounter with an examination team, or some unfortunate news about a new addition to your Watchlist.

Generally speaking, most loans don’t migrate down this path in normal conditions. This is precisely the point though, normal conditions no longer apply and banks need to have the best tools at their disposal to forestay any issues with their respective portfolios and get back to doing what they love to do - making new loans. Here are some things for all lenders to keep in mind, prior to making any loans to a new customer, or in their dealings with their existing customers.

• When collecting the requisite financial information, ask the potential borrower for a schedule of debt, including monthly or annual requirements, creditor names, etc.
• If your loan is personally guaranteed, remember no one lives for free – calculate in living expenses, along with whatever personal debt requirements are apparent on their respective credit bureaus.
• Taxes need to be accounted for as well!
• Know your borrower! Do they have related businesses whose cash flow needs may impact the entity you are lending to?
• Does your guarantor, guarantee loans at other institutions? Ask the question! Contingent liabilities are often overlooked and can be substantial.
• K-1s, K-1s, K-1s – There may be unaccounted for distributions or contributions that will impact your calculations and need to be accounted for, both on the cash flow side (distributions), as well as the debt service side (contributions).
• When calculating cash available for individuals, DO NOT simply take the totals from the front of the personal tax return. Utilize the wages, interest, dividends, any refunds, capital gains (if recurring), retirement, pensions and SSI can be used if the borrower is of the appropriate age and move to Schedule C, E and F as each may have add-backs that would elude your cash flow.
• Did I mention K-1s?

Some extra work on the front end makes for a much stronger portfolio, and also can make a lender’s life much more pleasant during an examination.