October 31, 2013

Q: Do you think it is appropriate to count shareholder loans as cash flow to the individual since it will need to be paid back?

A: Loan proceeds should always be considered a source of cash to the borrower when the loan is made.

Please note that loans made to shareholders and partners are often not repaid.  Some of these loans are converted to distributions at year-end by virtue of a set of accounting entries that reclassify some or all of the loan as distributions.  Others are forgiven, and others are converted to salary after the fact.

If indeed a shareholder loan is instead repaid, consider it as a cash outflow for the owner and a cash inflow to the company at the time of repayment.

Q: Would you look at the company pre distribution in calculating debt service coverage?

A: Always calculate the company’s debt service coverage post – and not pre – distributions. Distributions are “cash out the door” and reduce the amount of company cash flow available to service debt.

If indeed you establish a covenant that limits or precludes distributions and your borrower fully understands your organization’s intent to enforce the limitation without waiver, it’s appropriate to modify projected cash flow to identify the potential impact.