When we were all very new to lending, a wise gray-haired lender drilled this into us: Cash Flow is the Primary Source of Repayment. We all rushed to write down those words of wisdom. And we remembered them. So went our introduction to “primary cash flow.” Now, who can lead a discussion about today’s hot topic, Global Cash Flow? The wise gray-haired lender of our youth may be gone. So I guess I’ll try to take his place.
What it is. Global cash flow takes into consideration primary cash flow (borrower’s cash flow), cash flow of the affiliates, and the cash flow of the principals. Here’s the formula:
Primary Cash Flow + Personal Cash Flow + Affiliate Cash flow = Global Cash Flow.
You’re a quick study so you’ve got that. Now, how will you use global cash flow?
How to Use it. And Not. Well first, don’t use global cash flow as a substitute for primary cash flow. Global cash flow isn’t necessarily a source of repayment of the loan. Why not? One reason: The affiliates may or may not be guarantors of the loan. If they’re not guarantors, there is no reason to think that their cash flow could be used to repay your loan.
Look at it this way: Let’s say your borrower owns two businesses. Your borrower is the primary owner of the first and the other business is an affiliate that did not guarantee the loan. Year after year your borrower is losing money on the first business. Meanwhile, the affiliate company is rolling in dough. Why would your borrower take money from the profitable company to keep the unprofitable company open? Throwing good money after bad is never a good idea.
And don’t be fooled when somebody says, “Primary cash flow is poor. But wow! Look at the great global cash flow!” Unless the entities comprising global cash flow have guaranteed the loan, global cash flow doesn’t mean much.
‘Catch 22’ Analysis Required. So if global cash flow isn’t a reliable source of repayment, why bother with it? Simple. SBA requires you to do an analysis of global cash flow. And they’re not just making busy work.* The point of calculating global cash flow is to measure whether the borrower, its affiliates and its principals are generating enough cash to cover all combined obligations. If your primary cash flow is good, but your global cash flow is poor, you run the risk of the business owner draining money from your borrower to cover personal obligations or obligations of the owner’s other companies.
Yes, I know we said that the principal cannot be relied on to take cash flow from an affiliate to prop up the cash flow of the borrower. It isn’t reasonable or prudent. But some borrowers might just do that: Take the cash flow of your borrowing business to prop up personal cash flow or that of a failing affiliate. Sometimes borrowers just are not prudent.
Wrapping it Up. The Goal of Your Cash Flow Analysis. While positive global cash flow is not a reliable source of repayment of your loan, negative cash flow can put your loan at risk. That’s why the goal of your global cash flow analysis is to show a minimum global cash flow of 1:1, meaning there is enough cash flow all around to cover everyone’s debt service and the principal’s living expenses.
Lesson Learned. Negative global cash hurts debt repayment. Good global cash flow doesn’t necessarily help.
Associate CDC/504 Programs
* Search as you will through the SOP. You will find no requirement to do a global cash flow analysis for 504 underwriting. But that does not mean you are freed from having to analyze global cash flow. 13 CFR §120.150 specifies SBA’s lending criteria for all SBA loans. And there you will find that SBA will consider (and by extension so will you) ” (i) The effect any affiliates…may have on the ultimate repayment ability of the applicant”. The only way to show that you did indeed consider what the regulation requires is to do a global cash flow analysis.