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Managing cash flow presents challenges that can impact an organization’s financial health. To navigate this difficult terrain, it’s essential to understand global cash flow (GCF) and some of the issues it can present.

The primary source of repayment is typically the cash flow from your borrower. You analyze the predictability and sustainability of the cash flow to repay the subject debt over time. The results of this analysis are typically the primary driver of the risk rating you assign to the credit.

Sometimes, you have to look beyond the borrower to understand the cash flow:

• What was the cash flow this past year (i.e., how did they pay us)?
• What is the predictable and sustainable cash flow that will pay us over time?
• Where does it come from?

The good news is that not every credit needs a GCF calculation. The information required from the borrowers/guarantors is much greater, and the analysis can be time-consuming.

Key elements of a typical global cash flow

The starting point for GCF is the cash flow available to service debt from the borrower, co-borrowers and other directly obligated entities. This cash is compared to all debt that needs to be serviced from the calculated cash flow, not just the subject debt.

The next step, and usually the more difficult one, is looking beyond the common income components of the personal guarantors to see what else is available. These other sources are not obligors on the subject loan. This process often starts with a review of Schedule E of the personal tax return.

Schedule E has two parts. Part I contains the results of the real estate holdings of the guarantor and contains sufficient information to develop the net operating income (NOI) of the properties individually and in total. The NOI is added to the GCF and the related debt on these properties needs to be deducted in the GCF calculation.

Part II of Schedule E is more complicated. Included on Part II is the pass-through taxable income, typically from partnerships and S corporations. This is pass-through taxable income, not cash. This is where the challenging work comes in.

• In order to include cash from a Part II entity, you need to look at the individual’s K-1 to see what level of cash distributions were made to the individual. Just because there is taxable income does not mean that any cash was made available or even could be made available.
• Assuming there were distributions made to the individual, and you include them in the guarantors’ cash flow (which is a component of the GCF), you have to review the financials of the entity that paid out the distributions.

  Is this level of distribution sustainable for the entity? Is there sufficient cash flow to support the entity, service its debts and pay out to the owners this level of distribution? Is this portion of the cash flow sustainable?

• If there is no K-1 available, you cannot include any cash flow from the Part II entity in your GCF.
• The statements must be of a comparable time period (all tax returns for the same year).

The development of an accurate GFC is not always easy. When it is required to substantiate the predictability and sustainability of the cash flow to repay the subject debt over time, it can tell a compelling story, if you have the correct information to build the story.

How Wipfli can help

Loan review is a critical component of your overall risk management. Wipfli’s loan review team has the experience you need to help mitigate risk and give your organization a better understanding of cash flow. Contact an advisor today to get started.