Pub. 3 2013-2014 Issue 4

12 O V E R A C E N T U R Y : B U I L D I N G B E T T E R B A N K S - H E L P I N G C O L O R A D A N S R E A L I Z E D R E A M S 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. turns of the borrower and all related entities; • Tax returns of all individuals; • Guarantor 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 in - dividuals, 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 Debt Service Coverage Ratio? Each bank should establish within its loan policy and pro- cedures, an acceptable minimum Debt Service Coverage (DSC) ratio. This can vary by type or size of loan, but should be based on prudent lending standards and in consideration of the level of risk that the institution and its Board are willing to assume. Minimum global DSC ratios can and should also be established, although they do not necessarily need to be at the same level as the individual borrower minimum DSC. For those lenders that engage in SBA lending, the follow- ing minimums are now spelled out in new procedures recently adopted: Guidance fromSBA’s SOP 50 10 5 (F) effective Janu- ary 1, 2014 Lenders must demonstrate the Small Business Applicant’s ability to repay the loan from the cash flow of the business by documenting: • For loans up to and including $350,000: • The Small Business Applicant’s debt service cover- age 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. Lender must document in the loan file the defi - nition 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 (OCF) as earnings be - fore interest, taxes, depreciation and amortization (EBITDA); • 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 (DS) 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 (OCF/DS) must be 1.15 to 1 or greater on a historical and/or projected basis: • For projected cash flows, the Lender should pro - vide the calculation of debt service coverage using the definitions above, and provide analysis of the assumptions supporting the projected cash flow. In summary, your bank’s underwriting for business loans needs to take into account not only cash flow and debt service coverage ratios for the Applicant, but also a Global DSC that encompasses all related entities and guarantors. If you are do- ing SBA lending, the cash flow ratio of 1:1 (both Applicant, and Global) for loans up to and including $350,000 is based on the lender’s calculation. For loans over $350,000 the 1:15 cash flow ratio is based on the SBA’s specific EBITDA formula. If you need assistance in designing an underwriting model that takes into consideration these prudent (and required if you are doing SBA lending) standards, please contact Vern Hansen at vern@jrbrunoassoc.com or 720-663-8431. n Vern Hansen http://www.jrbrunoassoc.com/about/team.html heads the Colorado office of J.R. Bruno & Associates, a leading nationwide consulting firm to SBA and business lenders. He brings 40 years of banking and commercial lending experience to J.R. Bruno, and has served in executive positions including president and execu - tive vice president-chief lending officer at several regional and community banks.  GLOBAL CASH – continued