Calculating Global Cash Flow and Debt Service Coverage

Editor’s Note: This article first appeared on the J.R. Bruno & Associates website. It is reprinted with permission here.

The NCUA and FDIC are now underscoring that calculating global cash flow and global debt coverage is part of prudent underwriting and risk assessment that institutions should practice for Small Business Administration and member business loans. For SBA's Small Lender Advantage program it's required.

Rather than just measuring the income and debt service requirements of the borrower, global analysis combines available cash flow from the borrower and all affiliates and all guarantors, to give a global ‒ combined picture ‒ of cash available for meeting all global debt service obligations of all parties.

This assessment helps measure the risk of non-borrowing but related entities (and guarantors), of their becoming a drain on the borrower's cash flow resources. To make this analysis, you'll need:

• financial statements and tax returns of the borrower and all related entities;
• tax returns of all individuals;
• borrower's personal financial statement;
• debt schedules on the borrower, and all related entities and individuals; and
• K-1's from all entities and individuals.

Why do you need K-1s? Remember that reported taxable income from a tax return is not the same as cash flow. For individuals, taxable income from Schedule E partnerships and S-corps is not cash flow. You need the K-1's to determine true inflow or outflow of cash from these entities.

What's an Acceptable Global Debt Service Coverage Ratio?

Following is guidance from SOP 50 10 5 (F) effective January 1, 2014.

Lenders must demonstrate the small business applicant's ability to repay the loan from the cash flow of the business by documenting several things.

For loans under $350,000:

• the small business applicant's debt service coverage ratio exceeds 1:1 on a historical or projected cash flow basis; and
• with the exception of loans under $50,000, the small business applicant's global cash flow coverage ratio exceeds 1:1 on a historical basis or projected cash flow basis. The lender must document in the loan file the definition or formula used to calculate global cash flow.

For loans over $350,000, up to and including $5 million:

• analysis of historical cash flow should demonstrate total debt service coverage after the SBA loan;
• define operating cash flow as earnings before interest, taxes, depreciation and amortization;
• analysis must document additions and subtractions to cash flow such as:
  • unfunded capital expenditures;
  • non-recurring income;
  • expenses and distributions;
  • distributions for S-Corp taxes;
  • rent payments;
  • owner’s draw; and/or
  • assessment of impact on cash flow to/from any affiliate business;
• Debt service is defined as required principal and interest payments on all business debt inclusive of new SBA loan proceeds. The small business applicant’s debt service coverage ratio (operating cash flow/debt service) must be 1.15 to 1 or greater on a historical and/or projected basis:
  • For projected cash flows, the lender should provide the calculation of debt service coverage using the definitions above, and provide analysis of the assumptions supporting the projected cash flow.

In short, the cash flow ratio of 1:1 for loans under $350,000 is based on the lender's calculation. For loans over $350,000, the 1:5 cash flow ratio is based on the SBA’s specific EBITDA formula.  

Joanna Bruno is president of J.R. Bruno & Associates, San Francisco, a consulting firm to SBA and member business lenders nationwide. Reach her at joanna@jrbrunoassoc.com.