The definition of “global cash flow” is bantered around endlessly by bankers and federal regulators alike. It’s common knowledge that upon assessing repayment risk on a small business loan, it’s important to understand the big picture— which is not limited to the business, and includes analysis of the cash flow situation of any individual signer or guarantor. Global repayment risk assessment can become even more complicated; for instance, a commercial real estate investor can have several entities with each either demanding or providing cash.
Business vs Individual Cash Flow
What no one can seem to agree on is how to come up with one common methodology that is applicable across the banking industry. We all acknowledge that we need to take the big picture into consideration, we just don’t agree on how to do it. All cash inflows and outflows for a business are identified by scrutinizing the cash flow statement or by reviewing the balance sheets and income statements – but, cash flow for an individual is an entirely different story!
While we can see taxable income and deductions on an individual tax return, and gleam some information regarding assets and liabilities by reviewing the personal financial statement and credit bureau report, we don’t have any documentation that details the amount of cash that individuals are actually spending on living costs or discretionary expenses. We as consumers know that individual spending habits can differ drastically, so when we assess cash flow from a lender’s perspective and derive calculations such as using a percentage of Adjusted Gross Income (AGI) as a benchmark for discretionary spending, we know it is really a wild guess – but we also know that this estimate may be the closest we can get.
Consider the anecdotes about Warren Buffett’s frugal, low expense lifestyle. Mr. Buffet is certainly not spending 20% or 40% of his AGI for living and discretionary expenses while an ordinary person probably spends a lot more than 40% of their discretionary income!
Even within banks, adjustments to agreed-upon calculations are often based on individual situations and can vary depending on who is completing the analysis. I have spoken with several bank regulators on the topic of global cash flow and there simply isn’t a standard measurement of global cash flow outlined in the regulation manual. What examiners are looking for is a consistent methodology applied throughout the bank to address global cash flow and that the methodology makes sense. One of the banks I have worked with chooses not to factor in expenses; instead it utilizes a higher debt service benchmark to account for discretionary expenses.
So how should global cash flow be calculated?
At Omega, our self-paced e-learning programs highlight the importance of global cash flow, and reviews concepts related to global cash flow; however, we don’t put a stake in the ground as to an exact calculation. We analyze Omega case studies in the classroom and blend in the bank’s own methodology, policies, and procedures to calculate global cash flow and to determine whether it presents strength or weakness.
I believe that the most important factor to keep in mind when calculating global cash flow is to carefully review each borrower’s situation on a case-by-case basis. Furthermore, should you deviate from your bank’s standards, you need to be able to support why you felt the adjustments were necessary.
This topic certainly warrants more discussion and it will be interesting to see how global cash flow analysis, and standards that govern this analysis, evolve over time.
About the Author
Andrea Binkley is a commercial credit subject matter expert and a Senior Business Solutions Consultant at Omega Performance.