Global Cash Flow Analysis: What, When, Why and How

Global Cash Flow Analysis:
What, When, Why, and How

About Sageworks
 Financial information company that provides credit and risk management
solutions to financial institutions
 Data and applications used by thousands of financial institutions,
corporations and accounting firms across North America
 Awards
 Named to Inc. 500 list of fastest growing privately held companies in the U.S.
 Named to Deloitte’s Technology Fast 500
2

Introduction
1. What is global cash flow analysis?
2. Why is global cash flow analysis important?
3. When to use global cash flow analysis
Performing a global cash flow analysis
1. How is global cash flow analysis performed?
2. Best practices for global cash flow analysis
Special considerations in global cash flow
1. Common mistakes
2. Global cash flow as part of larger global analysis
3. Q&A
Agenda
3
Introduction
Special Considerations in global cash flow

Introduction
1. Common mistakes
3. Q&A
Agenda
4
Introduction

Introduction
1. Common mistakes
3. Q&A
Agenda
5
Introduction

Cash Flow Analysis
6
Cash Flow
The amount of money that moves in and out of a relationship
Introduction

Global Cash Flow: Counting
7
business
+
= 2 apples+
+
+ = 2 people
= 2 businesses
real estate
business
real estate
person person
= 2 properties
Introduction

Group = Global Cash Flow
8
personbusiness
+
Global Group
Introduction

9
personbusiness
+
real estate
+ person
Global Group
Introduction

10
person
business
+
real estate
+
real estate
personbusiness person
Global Group
Introduction

Understand the overlap of information:
 Income
 Debt Service
 Assets
 Liabilities
What is Global Cash Flow Analysis?
Introduction

 Used to analyze the cash flow of a group of entities that are tied
to one or multiple loans.
 These entities include guarantors, businesses, income-
generating real estate properties, and any combination therein.
What is Global Cash Flow Analysis?
12
Business(es)Business(es) Personal
Guarantor(s)
Personal
Guarantor(s) Real EstateReal Estate
Global Cash FlowGlobal Cash Flow
Eliminate Double-CountingEliminate Double-Counting
Real EstateReal Estate
Introduction

 A few years ago, my colleague’s father (John) sought to purchase
another hotel property along with a family friend (Eric)
 The two files of financials that were being submitted to two different
banks were of different sizes
 Eric’s bank (Bank A) asked for the business financials for the new
purchase, and the personal financials for both of them. I don’t think
anyone would be surprised by this
 However, John’s bank (Bank B) asked for more information. Bank B
wanted the financials for John’s two existing hotels and Eric’s three
existing hotels
 Same project, same hotel, same loan, but two very different processes
and sets of information were required for the lending decision
 Why global cash flow analysis?
Why is Global Cash Flow Analysis Important
13
Introduction

Example from a Colleague
14
John
+ Hotel
Hotel
Hotel
Eric
Introduction

Example from a Colleague
15
John
+ Hotel
Hotel
Hotel
Eric
Introduction

 In many ways, business and personal cash flow may be combined:
 It’s common for owners to lend personal funds to, or borrow funds from,
their businesses.
 It’s common for the business (for tax advantages, primarily) to rent its
office/warehouse/production facilities from a real estate holding company
or partnership controlled by the business owners.
 It’s common for owners to control their own levels of salaries, bonuses,
benefits, and dividends to the extent allowed by prudence and tax
regulations.
Why is Global Cash Flow Analysis Important?
16
Introduction

Why is Global Cash Flow Analysis Important?
 Without global cash flow analysis:
 Income or debt could be easily overstated.
 Loan decisions could be made with inaccurate debt and cash flow information.
 Scenario: A high net worth guarantor, who has all of his assets tied up in non-
cash producing real estate or a business venture that is losing money, may not
have the capacity to support the debt if the bank calls upon him to honor his
guarantee. Without a global analysis, the bank wouldn’t know about this risk.
17
Introduction

Two Types Discussed
 For CRE investors / owners (often 10+ properties with varying levels of
ownership):
 Compare total RE Cash flow to Personal Cash Flow measure
 Easier to do it this way because of varied % ownership, varied data formats and
level of detail, and resistance from customer to get detail on projects not financed
by the bank
 For small business / self- employed / C&I situations:
 Can also include CRE, but primary cash flow from operating business
 Analyze all business and individual holdings (cash flow and debt service)
 Analyze all entities associated as obligors or guarantors
18
Introduction

Global Cash Flow Analysis- When to Use?
 When?
 Small business where guarantor income important
 Works well with small number of owners (<3) and 70-100% aggregate ownership
 Business income primary source of income
 Recognizes commingled nature of personal and business income
 Best Practices:
 Business and Personal Income combined with no double-counting
 Business and Personal Debt combined
 Lines of Credit fully drawn; higher than minimum payments for credit cards
Ex. Line of Credit
 Current balance: $250,000 @ 5% int. rate mo.pymt: $4,784
 Full commitment: $500,000 @ 5% int. rate mo.pymt: $9,568
19
Introduction

 According to the OCC’s Internal Guidance from April 9, 2008:
“An analysis of the guarantor’s global cash flow should consider inflows, as well as
both required and discretionary cash outflows from all activities. This may
involve integrating multiple partnership and corporate tax returns, business
financial statements, K-1 forms, and individual tax filings. Anything short of a
comprehensive global cash flow analysis diminishes confidence in the
assessment of guarantor strength, even in the face of significant liquid assets
since that liquidity may be needed to fund contingent liabilities and global cash
shortfalls.”
How is Global Cash Flow Analysis Performed?
20
Introduction

21
Introduction
Best Practice: Use Tax Forms to Calculate
Personal Cash Flow and Contributions from
Pass Through Entities

22
Introduction

23
Introduction

Schedule E II (Available) vs. K-1 (Distribution)
24
Introduction

Distributions
25
Introduction

26
Introduction

27
Introduction

28
Introduction

29
Introduction

30
Introduction

Full Business Cash Flow or K-1 Distributions
 Some lenders include K-1 Distributions (Contributions) only, regardless of
percent ownership
 This approach is not necessarily a true global analysis if they are not also
including any of the debt service from the business entity in instances where the
individual is a clear majority owner
 Others will base their decision on the percent ownership
 For pass-through entity where individual has majority ownership (70-100%), will
include full business cash flow (and debt service)
 For pass-through entity where individual has clear minority ownership (<30%),
include K-1 distributions (contributions) only; exclude most if not all debt service
 In between situations, must use judgment
31
Introduction

32
personbusiness
+
Introduction
Business Cash Flow
E part II (Available) or K-1 (Distributions)

33
personbusiness
+
person
Introduction
Business Cash Flow
E part II (Available) or K-1 (Distributions)

Double Counting Adjustments
Introduction

Double Counting Adjustments
Introduction
❶Best Practice: When available, use the K-1 input to
show the cash flow to the individual, rather than the
schedule E part II. The program will not allow you to
use both and E-2 and a K-1 for the same business.

Decisions in the Personal / Global Cash
Flow Process
36
• PCF: Gross or Net?
• Other Regular and
Dependable Sources (Capital
Gains?)
•K-1 distributions
Introduction

Using Averages or Most Recent
Debt Service Coverage (DSC)
 Common practice:
 If no clear trend, use average DSC
 If improving, use average DSC to account for cyclicality
 If deteriorating, use most recent DSC
 Current environment:
 Because of severe deterioration in business conditions in 2008-2010, some
lenders will more heavily weight average to most recent years because it is more
reflective of “normal” conditions
37
Introduction

Global Cash Flow- Mixing Two Approaches
 Combining business and personal cash flow is combining two different
approaches (DTI/ DSC) that look at things differently
 DTI generally Gross (doesn’t subtract out living expenses and taxes)
 DSC is generally net of living expenses and taxes
 How to combine?
 Make both net (most prevalent approach); use 1.25x target DSC
 Leave them as is and try to combine, require higher minimum acceptable DSC
38
Introduction

Combining Cash Flow for Global Analysis:
Net Method
 Net Method Advantages
 Taxes are a clear issue in cash flow
 Takes into account detailed expense data
 Should be used for larger customers; favored by larger banks
 Net Method Disadvantages
 Tax computations complex
 Living expense formulas arbitrary and subjective
 False sense of accuracy
39
Introduction

Combining Cash Flow for Global Analysis:
Gross Method
 Gross Method Advantages
 Doesn’t attempt to compute taxes which can be complex and error-prone
 Avoids arbitrary assumptions for living expenses
 Gross Method Disadvantages
 Combines two non-parallel approaches
 Leaves individual cash flow on gross basis, with business income net
 Target DSC adjusted to 1.75x- 2.0x rather than 1.25x for business only
 Less subjective and complex; useful for most situations
40
Introduction

Recurring vs. Nonrecurring Items
 Capital Gains often cited as most complicated issue lenders / analysts face
 Instance of stock sale
 Cash flow is the proceeds not the gain or loss
 Is the stock sale recurring based on the borrower’s history?
 If so, do they have similar assets to make future sales at the same level?
 How were the proceeds used?
 Form 4797/Form 6252 Capital Gains
 Form 4797- Sales of Business Property
 Is this recurring? Do they have other properties? How are proceeds used?
 If not recurring, should taxes used in analysis be adjusted?
 Form 6252- Installment Sale Income
 Usually recurring
41
Introduction

Other Items of Increasing Importance
 Net Operating Loss carry-forwards and carry-backs
 Exclude the Net Operating Loss carry-forward as noncash item
 May need amended tax returns for prior years if using NOL carry-back
 Section 179 Deduction
 Ability to write off qualified equipment purchases even on last day of the year
 Limited to small businesses by phase-out where purchases over set amount
reduce the write-off
 Amount allowed for deduction and amount of phase-out have been increasing
based on recent legislation
42
Introduction

Global Cash Flow- More Complex Situations
 Both Gross and Net method as described use a simplified business cash
flow (Net Income + Depreciation + Interest)
 Preferable to use a full UCA Statement of Cash Flow analysis of the
business for larger situations, which examines sources/ uses of cash flow
from changes in Balance Sheet items
 For situations involving more than 3 guarantors, some suggest an
alternative approach to GCF
 Use the Net Personal CF after Debt Service for each individual and add to the
total business cash flow
 Use target DSC of 1.5x
 Example: Law firm with 25 partners
 Standalone Business CF and the Global Cash Flow should be examined
43
Introduction

 Common Mistakes:
 Obtaining business and personal financials, but not combining them into a
single cash flow
 Overlooking or not requesting all of the necessary tax forms
 Not obtaining additional needed information beyond the tax forms
 Neglecting to discern any overlapping income in the single cash flow
figure
 Allowing employees to use inconsistent global cash flow methodologies
 Things to Watch:
 Distributions can be misleading when taken in isolation. Sometimes
owners choose to pay themselves more or less depending on the
economic environment or the business’s position
 Financial data from recent periods should not be treated similarly to
financial data from past periods. They need to be reviewed in context
 Situations with multiple borrowers or guarantors should be fully analyzed
to take into account any low performing business for which the guarantors
are responsible
Common Mistakes in
Global Cash Flow Analysis
44
Introduction

GCF as Part of Larger Global Analysis
 10/30/09 Policy Statement on Prudent CRE Loan Workouts
 Updated and comprehensive financial information on the borrower, real estate
project and any guarantor
 An analysis of the borrower’s global debt service that reflects a realistic
projection of the borrower’s and guarantor’s expenses
 Global Debt is the aggregate of a borrower’s or guarantor’s financial obligations,
including contingent obligations
 “Sufficient information on the guarantor’s global financial condition, income,
liquidity, cash flow, contingent liabilities, and other relevant factors… to
demonstrate the guarantor’s financial capacity to fulfill the obligation… should
include total number and amount of guarantees extended by a guarantor in order
to assess whether the guarantor has the financial capacity to fulfill contingent
claims that exist.”
45
Introduction

Presenter Contact Information
46
Chuck Nwokocha
Director of Advisory Services
(919) 851-7474 ext. 637
chuck.nwokocha@sageworks.com
www.sageworksanalyst.com

Global Cash Flow Analysis: What, When, Why and How

Recommended

Recommended

More Related Content

What's hot

What's hot (20)

Viewers also liked

Viewers also liked (20)

Similar to Global Cash Flow Analysis: What, When, Why and How

Similar to Global Cash Flow Analysis: What, When, Why and How (20)

More from Libby Bierman

More from Libby Bierman (20)

Recently uploaded

Recently uploaded (20)

Global Cash Flow Analysis: What, When, Why and How

Editor's Notes