It clearly takes cash flow to pay down a business loan.
There are five places for it to come from in a business:
- Cash
flow from operations - Cash flow from selling off assets
- Cash
flow from borrowing money from someone else - Cash flow from
owner capital contributions - Cash flow from running down cash
balances
When you consider whether the business can afford the loan they are
requesting, look to see if cash flow from operations will cover it.
The other four are the back-up plan.
If you already have a loan in play and the cash flow from operations in recent periods has been insufficient,
the Statement of Cash Flows can show you where the company is getting
the money instead.
Cash flow from selling off assets
This will make a lender nervous. If the company has taken this route, find out if the assets they sold are no longer needed in their current business model. If they are critical to operations, is the company
now leasing the same equipment on an as needed basis? Do they plan to
continue this or do they expect to replace the equipment?
Cash flow from borrowing money from someone else
Yikes! This will definitely make a lender nervous. Find out what
the company’s overall plan is and when they need to pay those loans back.
Borrowing long-term to solve short-term operating losses is generally
not a good idea. That said, during a downturn the fact that the company borrowed
from someone else and kept current on your loan payments might be a
plus.
Cash flow from owner capital contributions
If the company is short operating cash flow to pay their debts, this might be
the source you as a lender would most like to see. ‘Coming to the table’ to
save the day is a good thing. Of course, you might wonder where the
capital contributions came from and if that leaves the owner short personally.
Cash flow from running down cash balances
If the company had excess liquidity this is okay in the short run. The
reason to have good liquidity is to have a back-up plan in a downturn. Look to see how much longer the company can do this without leading to a cash shortage.
