How Banks Use PERSONAL Tax Returns
I get this question a lot from business owners. If you want a business loan, you'll have to give the bank copies of your personal income tax returns (usually the three most recent years). No tax returns, no loan.
It's how the game is played today.
It's fair to ask the question - what's my banker looking for?
In a lending relationship, the bank wants to make sure the loan will be paid back - principal in full and related interest. Sounds so simple.
Bankers know that the borrower's cash flow before debt service on the requested loan pays them back. The key is cash flow. Income hints to cash flow, but is not synonymous with it.
If you're a guarantor of business debt, it's a little different. The bank is interested in your free cash flow as a secondary source of repayment if the borrower defaults. Again, it's all about cash flow.
In varying degrees, bankers are skilled in extracting cash flow from your Form 1040. They're trained on how to convert the numbers on the tax return to cash inflow, outflow amounts. I know this well - I've been training them for 30 years.
Sometimes, your banker will do the cash flow 'number crunch'. Other times, the number crunching is done by a credit analyst. Larger banks tend to favor having the credit analyst do this, but that's not always the case. In my training courses of late, I'm finding larger banks now insisting the relationship manager do some of the number crunching rather than relying on the analyst. This change is in response to the resent financial crisis, or as one of my southern colleagues puts it 'the recent economic unpleasantness'.
Some years ago now, one of my CPA Firm clients told me "Mike' I just hate giving my tax return to the bank. I really don't believe the banker knows what he's looking at. I'm aggressive in my tax planning and the numbers on the return reflect this. The banker doesn't appreciate this - to the contrary, I feel judged."
Understood. And, it may be true. But, I've found plenty of bankers who understand aggressive tax planning issues conceptually (absent the detailed structure) and know how to get behind the numbers to the cash flow issues. They're out there.
May I suggest this approach. As a business owner, your relationship with your lender will be strengthened commensurate with your knowledge of your business and personal finances. The better prepared you are, the better your chances of getting what you want from the bank. This preparation includes anticipating what the bank is looking for. Makes sense.
I've put together a template (Excel based) that shows you what the banker is looking for within your Form 1040. It also computes your personal net cash flow using the techniques your banker uses. And, it creates a list likely follow-up questions the banker will ask, and your suggested response!
Interested? For more information, click on the side menu item TOOLS For The Business Owner.