Usually one of the strongest credit aspects when financing an advisor practice acquisition is the consolidated cash flow that is available from the practice that is being purchased, and the existing practice of the buyer. Often, the practice being acquired can comfortably service the project debt associated with the practice acquisition. This is an ideal situation for both buyer and lender, and generally this scenario results in excellent rates and terms due to the reduced risk profile.
What is Global Cash Flow?
While consolidated cash flow is important, what is even more important to determine credit risk is the global cash flow, which also accounts for any borrower outside business activities and their personal household income needs.
How is Global Cash Flow Calculated?
Including outside business activities is pretty straight forward. A lender will look to your personal tax return and include net income results from all Sch C and Sch E entities, as well as consider any existing debt these businesses are currently obligated to pay. A lender will also consider any “add-backs” including non-cash expenses such as interest, depreciation, and amortization. This is helpful for the borrower as “Add-backs” increase the debt coverage ratio. Where global cash flow gets a bit messier is in how a lender estimates the personal income needs to support a borrower’s household. We’ll cover that in more detail.
Personal Discretionary Income
The method in which an SBA lender calculates personal discretionary income can vary widely, but the end result is to figure out how much of the consolidated cash flow from the practice remains available to service debt after the borrower’s personal income needs are subtracted.
First, we begin with capturing all of the income that is available. This could include Dividends, Interest Income, Sch C Income from non-related entities, Rental Income, Secondary Salary/Wages from a spouse, etc. Next, we begin to evaluate the borrower’s personal expenses and we begin with Tax liabilities. We typically subtract Federal, State, Local and Real Estate Taxes based on the most recent tax return. We could also evaluate the projected tax liabilities if income is expected to change significantly, which is often the case with a financial advisor practice acquisition.
From there we begin to look personal debt obligations such as mortgages, auto installment loans, HELOC, credit cards, etc. We request this information on our Salt Creek loan application as part of the personal cash flow statement and then we match it up with what is reported on the borrower’s personal credit report.
Finally, we review personal living expenses. This number is self-reported by the borrower as part of the personal cash flow statement on the Salt Creek loan application. We ask borrowers to estimate the minimum amount they need for everyday living. This includes items such as insurance, health care costs, clothing, children’s tuition, utilities, cell phone bills, gas for the car, you name it. It’s basically your minimum monthly budget excluding non-debt related items. This number typically climbs as the borrowers AGI climbs. Often this number is grossly underestimated by a borrower. This is usually not intentional, it’s just most people just don’t realize how much income goes out the door to support their quality of life. Taking additional time to fully evaluate your personal living expenses provides the lender a higher level of comfort knowing that you have done your due-diligence on the global cash flow requirements needed to support the new acquisition debt.
Why is Global Cash Flow Important?
Global Cash Flow is important because typically not all of the net income from the business is available to service the proposed debt. It is not very often that a borrower does not need any income from their financial advisor practice to support their household. Almost always, some of the bottom-line income is used to buy groceries or put gas in the car. It’s the global analysis that helps a lender establish how much of the net income is truly available to pay the newly acquired debt. This method is particularly important for advisors that use a Sch C to report income from their financial advisory practice, and not a corporate return where they may be paying themselves a salary. If you would like to learn more on how we calculate cash flow please reach out to a Salt Creek Loan Advisor today.
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Our goal is to offer potential borrowers a pre-qualification determination within 48 hours of receiving a completed loan application. To get started, contact us today or download our financial advisor loan application now. Then, speak with a loan advisor or send the completed application using our secure document portal. Call us anytime with questions at (402) 858-1249.