Global Cash Flow Questions (February 18, 2010)
 
Q:  Fresno is the Borrower.  Are the other related entities guarantors?
 
A:  In our example, no related company guarantees Fresno debt.  Schumacher guarantees Fresno, Modesto, and Sequoia debt but NOT Clovis debt. No party guarantees Clovis debt, although all the assets are secured.

This question does bring up a valid subject concerning company and personal guaranties. In many cases, a bank may require cross company guarantees on related companies in cases where there is significant financial dependency or interaction among and between related parties.

Q:  If the Borrower was only Fresno, we wouldn't have information on other parties, so we really could not create proper cash flow analysis, right?

A. You are correct, except that every lender has the right to request all necessary financial information from a borrower in order to make a prudent lending decision. In our case, since Fresno Properties and Fritz Schumacher are linked to related parties through common ownership, we need and should require all related party financial information.

In addition, the financial regulators are stressing the importance of collecting and assessing all data necessary to undertake a global financial and cash flow analysis.  That point was emphasized especially in the regulators’ October 30, 2009 policy statement.  Therefore, it will become increasing important for lenders to acquire and use this information in assessing risk.

Q: I was always under impression that if it's an income producing property then you calculate DSC by taking NOI + depreciation + interest expense divided by total debt payments on proposed and existing debt to this company. Is this not correct? You mentioned cash flow earlier.
 
A:  This is one way of doing it, but the operating statement for an Income Producing Property does NOT include depreciation. So it's simplest to divide NOI by debt service, which is the standard approach. Note that the F/S for actual borrower - the party that owns the IPP - will reflect depreciation expense.

In addition, Business Profit is defined as reported net income from the income statement minus the sum of a) distributions or withdrawals and b) loans to owners in the period.  Distributions and loans represent cash outflows for personal income tax payments on company profit or owner compensation – or both.  Since distributions, withdrawals, and shareholder loans are not recognized as expenses according to income tax regulations and guidance – and associated GAAP – they are reflected on the balance sheet and not passed through the income statement.  Business Profit reclassifies these operating expenses for income taxes and compensation as proper operating expenses on the income statement and, therefore, adjusts reported net profit by the sum of these two operating expense amounts.

The key issue is whether there is sufficient actual or business profit at the end of the day to pay down long-term debt as scheduled.  And even though depreciation expense is a non-cash expense, it does serve as a proxy for the actual cash outflow a company provides to maintain its fixed assets.  Maintaining property, plant, and equipment is a real expense, even though the measure of it in the income statement is an approximation only.

Business profit does not pretend to represent cash flow.  It represents actual business profit after adjustments for all “off income statement” expenses.  The best cash flow statement, in turn, is the Uniform Credit Analysis (UCA) Cash Flow statement, not traditional “cash flow” defined as net income plus non-cash charges. Recall that we used the UCA cash flow statement to understand cash flow movements within and between related parties in the webcast presentation.