In my seminars, I often hear bankers use the term 'global' cash flow. And, it's often used as though everyone in the room knows the definition. Alas, I'm 'the odd man out'.
Is there a universal definition? I think not.
Let's discuss the concept of 'global' cash flow. Maybe we can establish some acceptable, shared understanding of the concept and its practical application.
Not long ago, a student offered his definition of global cash flow - "it's what I use when the actual cash flow of the borrower comes up short. and I need to salvage the deal." Swell.
Seems as though most definitions of 'global cash flow' have this in common - the personal cash flow (PCF) of the borrower (guarantor) is 'blended' with the cash flow of the related business(es). The idea being the lender wants to know where the cash is if 'push should become shove'. I have no problem with the intent. It's the 'blending' of the PCF with the business cash flow that concerns me.
Consider this diagram.
The personal global cash flow of the individual borrower (or the individual as guarantor) includes the individual's personal cash flow (PCF). I teach bankers how to calculate this amount using the individual income tax return of the customer.
Next, calculate the stand alone cash flow of any business your customer owns. This can be tricky.
- If your borrower is an individual, then
Calculate the stand alone cash flow of any business your customer owns.
- If your borrower is a business owned by your customer (customer is guarantor), then
Calculate the stand alone cash flow of any business your customer owns excluding the borrowing business .
So far, so good.
If the resulting stand alone business cash flow is positive:
- Optimistic approach - multiply that positive cash flow by your customer's ownership percentage. Add this result to your customer's personal cash flow (PCF) to create personal global cash flow. Some will argue this optimistic approach 'added fuel to the fire' in the most recent lax lending environment. It's fallen from favor with many lenders.
- Cautious approach - Do nothing; don't add your customer's share of the business cash flow to the personal cash flow (PCF). Another way of saying it - don't use a global cash flow model. This may be severe, but in the present lending environment it has its proponents.
If the business cash flow is negative:
- Skip the optimistic approach entirely. It's just not prudent.
- Cautious approach ALWAYS - Subtract your customer's share of the negative business cash flow from the customer's personal cash flow (PCF). Do this even though your customer might not control the related business entity. In theory, if the business has negative cash flow, it's just a matter of time before the cash shortfall necessitates a cash capital infusion from your customer.
Finally, in calculating cash flow, I'm only interested in those cash flows of a recurring, predictable nature. One time items are excluded.