Cash Flow Analysis and Borrowing Causes
Q: Hypothetically speaking, if we took the personal guarantee of all 20% owners of the company, wouldn't global cash flow look better to service debt?
A: It depends. Including excess cash flow of guarantors can add to the cash flow or resources base available to service the borrower’s debt. This aggregated approach assumes, however, that the guarantor(s) indeed have cash flow, or more importantly, liquid assets readily available to support the company. This rationale further assumes that the cash flow or liquid resources remain available after the guarantor satisfies the cash demands associated with living / lifestyle expenses, taxes, medical expenses, and personal debt service. If these assumptions don’t reflect reality, the guarantor(s) may add little to the company’s financial strength.
All too often a guarantor’s personal cash flow is heavily dependent on the company and that cash flow may be seriously reduced or eliminated during difficult financial times at the guaranteed company. This consideration reduces the financial strength of the guarantor. Further complicating the situation is the fact that many guarantors are heavily invested in their company, which is generally a very illiquid investment. This combination makes liquid assets outside the company critical to the strength a guarantor adds to the deal.
Q: If the UCA cash flow is the true cash flow of a company, then why do banks and most lenders ask for accrual financials if, at the end of the day, we're only going to look at the cash changes?
A: Lenders ask for the borrower’s accrual based financial statements because they provide a quantified version of all the business activity conducted during the period reported. Financial analysis, which include cash flow analysis, is most useful when based on accrual financial statements.
In general, lenders look at a company’s profit or loss for the period in question and match it against the cash profit or loss for the period. The key issue is to identify the reasons for the differences and determine if they make a material difference in assessing the risk position of a borrower.
The borrower’s profit or loss for the period is identified in the accrual income statement. The cash profit or loss is identified by combining the accrual income statement and accrual balance sheet to determine cash revenue, cash cost of goods sold, cash operating expenses, cash distributions and loans (income taxes and owner compensation for pass-through companies), and, ultimately, cash profit and loss.
The accrual income statement by itself does not tell the whole story. The UCA cash flow statement by itself does not tell the whole story. We need both to conduct an effective assessment of a borrower’s risk position.
Q: The course handout is missing pages 57 and 58 that are on the screen.
A: The deck is indeed missing the solution slides (solution slides 57 & 58 are solution slides) for the six poll questions we conducted today. You’ll receive a follow-up email will include the written Exercise solutions, written answers to the poll questions, and written answers to the questions posed by the group.
Our intent to taking this approach is to allow you the opportunity to apply the knowledge gained from the webinar to answer the questions.
Course overview: Cash Flow Analysis and Borrowing Causes