Global Cash Flow Analysis:

What, When, Why, and How

Presented by:

Chuck Nwokocha

Director of Advisory Services, Sageworks

David Matricciano

Owner, DM Analytics LLC

About Sageworks

Financial information company that provides credit and risk management

solutions to financial institutions

Data and applications used by thousands of financial institutions,

corporations and accounting firms across North America

Awards

Named to Inc. 500 list of fastest growing privately held companies in the U.S.

Named to Deloitte’s Technology Fast 500

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About the Presenters

Chuck Nwokocha – Director of Advisory Services, Financial Markets –

Sageworks Chuck is a graduate of Harvard University, with a B.A. in Psychology with a focus in

Organizations and Economics. He began his professional career with Guardsmark, a private

security services company where he held various positions and responsibilities – in

operations, human resources, and sales, and management. He has founded two e-

commerce sites, Ndekanyi.com – a social networking site for the Igbo people and

SwapU.com – a college classifieds network. Additionally, he has consulted on Marketing,

Social Media, and User-Generated content. At Sageworks, Mr. Nwokocha leads the Advisory

and Bank Consulting team, focusing on Credit Analysis and Risk Rating.

David Matricciano – Owner – DM Analytics LLC David graduated from Rowan University in Glassboro, NJ after serving four years active duty

in the U.S. Marines. He began his professional career with Commerce Bank, NA performing

research for the bank’s chief economist. He then entered the bank’s credit training program

and ended up working as a credit analyst, underwriter, portfolio manager, and junior lender

for over 5 years. He formed DM Analytics, LLC in 2008 to assist banks with underwriting,

collections, work out, and loan review on a short term contract basis.

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1. What is global cash flow analysis?

2. Why is global cash flow analysis important?

3. When to use global cash flow analysis

4. How is global cash flow analysis performed?

5. Best practices for global cash flow analysis

6. Special considerations in global cash flow

7. Common mistakes

8. Global cash flow as part of larger global analysis

9. Q&A

Agenda

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Global Cash Flow

Complex borrower scenarios introduces fresh challenges for financial

institutions

Put standards in place across the credit and lending departments for when to

conduct a global cash flow analysis

What information to collect from borrowers

Best practices for conducting global cash flow analysis

How spreadsheet based programs can lead to inconsistencies

Double counting

How a probability of default can be implemented in the credit and lending

process

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Global Cash Flow: Counting

6

business

+

= 2 apples +

+

+ = 2 people

= 2 businesses

real estate

business

real estate

person person

= 2 properties

What is Global Cash Flow?

7

person business

+

real estate

+

What is Global Cash Flow?

8

person business

+ real estate

+

real estate real estate

What is Global Cash Flow?

9

person business

+ real estate

+

real estate real estate

person

What is Global Cash Flow?

10

person business

+

real estate

+

real estate person

business

person

Used to analyze the cash flow of a group of entities that are tied

to one or multiple loans.

These entities include guarantors, businesses, income-

generating real estate properties, and any combination therein.

What is Global Cash Flow Analysis?

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Business(es) Personal

Guarantor(s) Real Estate

Global Cash Flow

Eliminate Double-Counting

Real Estate

A few years ago, my colleague’s father (John) sought to purchase

another hotel property along with a family friend (Eric)

The two files of financials that were being submitted to two different

banks were of different sizes

Eric’s bank (Bank A) asked for the business financials for the new

purchase, and the personal financials for both of them. I don’t think

anyone would be surprised by this

However, John’s bank (Bank B) asked for more information. Bank B

wanted the financials for John’s two existing hotels and Eric’s three

existing hotels

Same project, same hotel, same loan, but two very different processes

and sets of information were required for the lending decision

Why? Global cash flow analysis

Global Cash Flow Analysis: Example from a Colleague

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Global Cash Flow Analysis: Example from a Colleague

13

John

+ Hotel

Hotel

Hotel

Eric

Global Cash Flow Analysis: Example from a Colleague

14

John

+ Hotel

Hotel

Hotel

Eric

In many ways, business and personal cash flow may be combined:

It’s common for owners to lend personal funds to, or borrow funds from,

their businesses.

It’s common for the business (for tax advantages, primarily) to rent its

office/warehouse/production facilities from a real estate holding company

or partnership controlled by the business owners.

It’s common for owners to control their own levels of salaries, bonuses,

benefits, and dividends to the extent allowed by prudence and tax

regulations.

Why is Global Cash Flow Analysis Important?

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Why is Global Cash Flow Analysis Important?

Without global cash flow analysis:

Income or debt could be easily overstated.

Loan decisions could be made with inaccurate debt and cash flow information.

Scenario: A high net worth guarantor, who has all of his assets tied up in non-

cash producing real estate or a business venture that is losing money, may not

have the capacity to support the debt if the bank calls upon him to honor his

guarantee. Without a global analysis, the bank wouldn’t know it about this risk.

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Understand the overlap of information:

Income

Debt Service

Assets

Liabilities

What is Global Cash Flow Analysis?

Understand the overlap of information:

Income

Debt Service

Assets

Liabilities

What is Global Cash Flow Analysis?

Global Cash Flow Analysis- Two Types Discussed

For CRE investors / owners (often 10+ properties with varying levels of

ownership):

Compare total RE Cash flow to Personal Cash Flow measure

Easier to do it this way because of varied % ownership, varied data formats and

level of detail, and resistance from customer to get detail on projects not financed

by the bank

For small business/ self- employed/ C&I situations:

Can also include CRE, but primary cash flow from operating business

Analyze all business and individual holdings (cash flow and debt service)

Analyze all entities associated as obligors or guarantors

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Global Cash Flow Analysis- When to Use?

When?

Small business where guarantor income important

Works well with small number of owners (<3) and 70-100% aggregate ownership

Business income primary source of income

Recognizes commingled nature of personal and business income

Best Practices:

Business and Personal Income combined with no double-counting

Business and Personal Debt combined

No such thing as interest only loans; include all as amortizing

Lines of Credit fully drawn; higher than minimum payments for credit cards

Ex. Line of Credit

Current balance: $250,000 @ 5% int. rate mo.pymt: $4,784

Full commitment: $500,000 @ 5% int. rate mo.pymt: $9,568

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According to the OCC’s Internal Guidance from April 9, 2008:

“An analysis of the guarantor’s global cash flow should consider inflows, as

well as both required and discretionary cash outflows from all activities. This

may involve integrating multiple partnership and corporate tax returns,

business financial statements, K-1 forms, and individual tax filings. Anything

short of a comprehensive global cash flow analysis diminishes confidence in

the assessment of guarantor strength, even in the face of significant liquid

assets since that liquidity may be needed to fund contingent liabilities and

global cash shortfalls.”

How is Global Cash Flow Analysis Performed?

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Best Practice: Use Tax Forms to Calculate Personal Cash Flow

and Contributions from Pass Through Entities

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Decisions in the Personal / Global Cash Flow Process

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• PCF: Gross or Net?

• Other Regular and

Dependable Sources (Capital

Gains?)

•K-1 distributions

Include Full Business Cash Flow or K-1 Distributions

Some lenders include K-1 Distributions (Contributions) only regardless of

percent ownership

This approach is not necessarily a true global analysis if they are not also

including any of the debt service from the business entity in instances where the

individual is a clear majority owner

Others will base their decision on the percent ownership

For pass-through entity where individual has majority ownership (70-100%), will

include full business cash flow (and debt service)

For pass-through entity where individual has clear minority ownership (<30%),

include K-1 distributions (contributions) only; exclude most if not all debt service

In between situations, must use judgment

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25

person business

+

Business Cash Flow (1040 schedule E part II or K-1 Distributions)

26

person business

+

person

Business Cash Flow (1040 schedule E part II or K-1 Distributions)

Understand the overlap of information:

Double Counting Adjustments

Understand the overlap of information:

Double Counting Adjustments

Using Averages or Most Recent Debt Service Coverage (DSC)

Common practice:

If no clear trend, use average DSC

If improving, use average DSC to account for cyclicality

If deteriorating, use most recent DSC

Current environment:

Because of severe deterioration in business conditions in 2008-2010, some

lenders will more heavily weight average to most recent years because it is more

reflective of “normal” conditions

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Global Cash Flow- Mixing Two Approaches

Combining business and personal cash flow is combining two different

approaches (DTI/ DSC) that look at things differently

DTI generally Gross (doesn’t subtract out living expenses and taxes)

DSC is generally net of living expenses and taxes

How to combine?

Make both net (most prevalent approach); use 1.25x target DSC

Leave them as is and try to combine, require higher minimum acceptable DSC

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Combining Cash Flow for Global Analysis: Net Method

Net Method Advantages

Taxes are a clear issue in cash flow

Takes into account detailed expense data

Should be used for larger customers; favored by larger institutions

Net Method Disadvantages

Tax computations are complex

Living expense formulas arbitrary and subjective

False sense of accuracy

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Combining Cash Flow for Global Analysis: Gross Method

Gross Method Advantages

Doesn’t attempt to compute taxes which can be complex and error-prone

Avoids arbitrary assumptions for living expenses

Less subjective and complex; useful for most situations

Gross Method Disadvantages

Combines two non-parallel approaches

Leaves individual cash flow on gross basis, with business net income

Target DSC adjusted to 1.75x- 2.0x rather than 1.25x for business only

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Recurring vs. Nonrecurring Items

Capital Gains often cited as most complicated issue lenders/ analysts face

Instance of stock sale

Cash flow is the proceeds not the gain or loss

Is the stock sale recurring based on the borrower’s history?

If so, do they have similar assets to make future sales at the same level?

How were the proceeds used?

Form 4797/Form 6252 Capital Gains

Form 4797- Sales of Business Property

Is this recurring? Do they have other properties? How are proceeds used?

If not recurring, should taxes used in analysis be adjusted?

Form 6252- Installment Sale Income

Usually recurring

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Other Items of Increasing Importance

Net Operating Loss carry-forwards and carry-backs

Exclude the Net Operating Loss carry-forward as noncash item

May need amended tax returns for prior years if using NOL carry-back

Section 179 Deduction

Ability to write off qualified equipment purchases even on last day of the year

Limited to small businesses by phase-out where purchases over set amount

reduce the write-off

Amount allowed for deduction and amount of phase-out have been increasing

based on recent legislation

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Global Cash Flow- More Complex Situations

Both Gross and Net method as described use a simplified business cash

flow (Net Income + Depreciation + Interest)

Preferable to use a full UCA Statement of Cash Flow analysis of the

business for larger situations, which examines sources/uses of cash flow

from changes in Balance Sheet items

For situations involving more than 3 guarantors, some suggest an

alternative approach to GCF

Use the Net Personal CF after Debt Service for each individual and add to the

total business cash flow

Use target DSC of 1.5x

Example: Law firm with 25 partners

Standalone Business CF and the Global Cash Flow should be examined

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Common Mistakes: Obtaining business and personal financials, but not combining them into a

single cash flow

Overlooking or not requesting all of the necessary tax forms

Not obtaining additional needed information beyond the tax forms

Neglecting to discern any overlapping income in the single cash flow

figure

Allowing employees to use inconsistent global cash flow methodologies

Things to Watch: Distributions can be misleading when taken in isolation. Sometimes

owners choose to pay themselves more or less depending on the

economic environment or the business’s position

Financial data from recent periods should not be treated similarly to

financial data from past periods. They need to be reviewed in context

Situations with multiple borrowers or guarantors should be fully analyzed

to take into account any low performing business for which the guarantors

are responsible

Common Mistakes in Global Cash Flow Analysis

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GCF as Part of Larger Global Analysis

10/30/09 Policy Statement on Prudent CRE Loan Workouts

Updated and comprehensive financial information on the borrower, real estate

project and any guarantor

An analysis of the borrower’s global debt service that reflects a realistic

projection of the borrower’s and guarantor’s expenses

Global Debt is the aggregate of a borrower’s or guarantor’s financial obligations,

including contingent obligations

“Sufficient information on the guarantor’s global financial condition, income,

liquidity, cash flow, contingent liabilities, and other relevant factors… to

demonstrate the guarantor’s financial capacity to fulfill the obligation… should

include total number and amount of guarantees extended by a guarantor in order

to assess whether the guarantor has the financial capacity to fulfill contingent

claims that exist.”

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Contact Information

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Presenter Contact Information:

Chuck Nwokocha, Sageworks

(919) 851-7474 ext. 637

chuck.nwokocha@sageworks.com

www.sageworksanalyst.com

David Matricciano, DM Analytics LLC

(609) 410-4949

dm4270@yahoo.com