Global cash flow, explained step by step

What it is

Coverage on one loan asks whether one property or one business can pay one payment. Global cash flow asks whether the people behind the loan can pay everything they owe. The OCC’s handbook for bank examiners says cash flow should be assessed on a global basis, and that the analysis may mean pulling together business statements, tax returns and Schedule K-1 forms for several partnerships, limited liability companies and corporations. It should count required and discretionary cash flows from all activities and any actual or contingent liabilities.

The reason is simple. A borrower with a strong building and a heavy personal debt load can still miss a payment, and a lender that only looked at the building would not have seen it coming.

The steps

1. Start with each business. Take its cash flow available for debt service, after the owners are paid, and adjust it the way the lender will. SBA’s list of adjustments for a 504 loan is rent payments, unfunded capital spending, non-recurring income, distributions, distributions to cover S-corporation taxes and ownership compensation.
2. Add the people. Add each guarantor’s income from outside the business. Add the pay the business gives them, because it is their income, and it was already taken out of the business’s cash flow in step one.
3. Take out taxes and living costs. The OCC says to use realistic projections of personal debt payments, property and income taxes, and living expenses.
4. Count every obligation. Debt service on the new loan, on all other business debt and on all personal debt. SBA requires a debt schedule from the applicant, including any shareholder debt.
5. Divide. Combined cash flow over combined debt service is the global ratio.

A worked example

A business buys the building it now rents. The loan is $2,400,000 at 6.5 percent over 25 years, which is $16,205 a month and $194,460 a year. The rent of $150,000 goes away, and property taxes, insurance and upkeep of $45,000 take its place. All figures are an example.

Global coverage is $537,000 divided by $316,460, which is 1.70x. The business alone, with the new loan and its other debt, covers 1.80x. The difference is the personal side.

Now change one thing. If the guarantor’s personal debt were $150,000 a year instead of $52,000, perhaps from loans on other rental property, the total debt service would be $414,460 and global coverage would fall to 1.30x. The building did not change. The loan did not change. The person behind it did. That is what global cash flow exists to catch.

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What SBA requires

For a standard 7(a) loan SOP 50 10 8.1 asks for a debt service coverage ratio of at least 1.15x on the business’s historical or projected cash flow and at least 1.00x on a global basis. The global analysis must assess the effect of any affiliate business on the applicant’s cash flow, and the rent the project property will pay may be included in it. For a 504 loan the development company must prepare a global cash flow and justify each addition and subtraction.

Two rules are worth knowing. The lender must explain why each adjustment or add-back is prudent and necessary and how the business’s operations support it, in the credit memorandum, and an adjustment without that analysis is ineligible for the test. And where owners’ pay has been adjusted, SBA requires a global analysis showing the principals can still meet their obligations, with ownership compensation sufficient to support their current obligations and living expenses.

Where lenders differ

No federal number applies to a conventional loan, so these are decisions each bank makes in its own policy:

• Taxes and living costs. Some lenders use the actual personal tax return and the borrower’s stated living expenses. Others use a standard amount by household size. Ask which.
• Distributions. Whether money an owner takes out of the business for taxes is added back or deducted.
• Capital gains. The OCC says to focus on recurring cash flows and to count anticipated capital gains only when income has been historically dependent on them.
• Contingent liabilities. Guaranties the owners have given on other loans. The OCC lists direct and contingent liabilities among the things a bank’s standards should evaluate.
• The minimum. Each bank sets its own. SBA’s 1.00x is the only published one.

Mistakes that cost deals

• Counting rent twice. If the business pays rent to a property entity the owners also own, the rent is an expense of one and income of the other. Count it once. The example above avoids the problem by working from the business’s cash flow after buying the building.
• Using net income instead of cash flow. Net income on a tax return is after depreciation and interest and before owner pay and capital spending. Start from cash flow and make the adjustments one by one.
• Leaving out the guaranties. Debt the owners have backed with their own guaranty for other entities is a contingent liability. A lender finds it in the tax returns and the personal financial statements.
• Leaning on savings. The OCC says a full global analysis should be done despite significant liquid assets, because those assets may be needed for other liabilities and shortfalls.

What the public record can tell you

Nothing about any borrower’s global cash flow. No call report, HMDA record or SBA file holds it. The public record shows which lenders make owner-occupied loans and SBA loans at your size. The lender’s credit officer tells you how the lender counts the rest.

General information, not legal, tax or credit advice. A lender's own policy decides what it will do; ask it for the policy in writing.