1/21/2015

Q: What's your thought in using the Cash Flow Statement (Sources divided by Uses for DCR) if presented by borrower in calculating cash flow instead on going through the task of seeking out numbers to calculate NOI?

A: My sense is that we may well miss the mark in calculating an entity’s ability to generate cash flow to service debt if we divide the sum all FASB 95 Statement of Cash Flows Sources by all the Uses presented in the same report. Such a computation would not get at the central issue which is whether the borrower generated sufficient cash flow from business operations alone to service interest-bearing debt.

The Uniform Credit Analysis (UCA) cash flow statement remains the most comprehensive and most reliable measure of how well a business performs in generating cash from business operations to service debt. Introducing the impact of changes in the balance sheet accounts as a line by line adjustment to the income statement, an action not taken by the FASB 95 Statement of Cash Flows, remains the most effective cash flow measure in identifying whether the borrower can, indeed, service its interest-bearing debt from business cash flow. And recall that business cash flow is our primary and preferred source of cash to service debt.

Q: What guidelines do you use to calculate living expenses as most borrowers never provide that information as IRS makes it difficult to utilize Schedule A anymore so we do not see very many Schedule As?

A: It’s important that we first recognize that we are compelled to rely heavily on our ability to “know the customer” and understand his or her lifestyle. Such knowledge and familiarity should help us develop some very rough estimates of personal living expenses. For example, it we become familiar with a guarantor’s community involvement, social status, and personal habits, we can use this knowledge as building blocks in establishing a fundamental estimate of personal living expenses.

We can also identify some actual personal expenses, such as alimony payments from the 1040, plus medical and dental expenses, along with contributions from information that may appear on Schedule A of personal income tax returns. A worst case scenario might be to reference the standard deduction claimed in the absence of more detailed Schedule A deductions as a partial estimate of living expenses.   

In a totally different approach, we can be guided by the fact that the average U.S. savings rate in recent years has been around 4% to 5% of disposable personal income (DPI). DPI is defined as “the amount of money that households have available for spending and saving after income taxes have been accounted for”. Using the complement to this statistic, individuals are spending roughly 95% of DPI on housing, personal living expenses, debt service, taxes other than income tax, and medical / other expenses.

Regardless of whether a guarantor provides information about his or her personal living expenses or we are compelled to estimate those expenses, the figure is very rough and highly uncertain in the best of circumstances.