As the activities of small business owners and the companies they run become more closely intertwined, more community banks are examining global cash flow when analyzing small business loan applications. This is especially true for loan requests from S corporations and LLCs.
Global cash flow integrates both business and personal cash flow to provide a more complete picture of the business’ and owner’s overall financial situation. A challenge for bankers is determining what is a reasonable amount of money to allot for the owner’s personal expenses when underwriting a business loan using personal and global cash flow. There are three common approaches:
1. The simplest approach is to determine the total amount of global cash flow (personal and business) after debt service and allot whatever is left over to the owner’s personal expenses. If you use this approach, make sure the amount that’s left over can realistically pay for the owner’s lifestyle.
For example, it would be counterproductive to underwrite a loan to a 1.25 debt service coverage ratio if this only leaves $5,000 a year for the owner and his or her family to live on.
2. The percentage method is another common approach. Here, you would allocate a percentage of personal cash flow (after taxes and before debt service) to the owner’s personal living expenses — 20-30 percent is common.
The bigger the owner’s lifestyle, the higher the percentage should be. Be sure you define specifically what the percentage will be measured against. With this approach, establish both a minimum and a maximum that will be allocated for the owner’s personal expenses.
3. The third approach is to allocate a fixed amount of money based on the number of family members. For example, you could allocate $25,000 for joint borrowers and $10,000 per additional dependent a year to personal living expenses.
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