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Can your Borrower really pay you back?

What is on your list?

Business lenders, underwriters and credit analysts consider ability to repay as the primary risk mitigation in making a business loan. And credit analysis includes calculating global cash flow from tax returns for small- and mid-size businesses to determine ability to repay. Fair enough. But besides operating cash flow, what else signals the ability to repay?

Before you read the rest of this post, make your own list of sources of repayment? Then put them in order.

Business Loan Repayment: An ordered list

Here is my list, and you might be surprised at the order:

1. Operations

No surprise here. The entire goal is that the business can generate sufficient cash flow to pay the loans on a timely basis. For smaller businesses we look at their tax returns. For larger businesses we look at CPA-prepared, compiled, reviewed or audited financial statements, depending on the size of the credit. (One of the live webinars I present in our online credit training for bankers at www.LendersOnlineTraining.com is on the variety of CPA-prepared statements and how to pick the right one.)

2. Liquidity

Did you have collateral as second? Did you only have two sources listed?

I put liquidity as number two because adequate liquidity is what allows for the bumps in the road that characterize business-as-usual. Many lenders have a liquidity benchmark that prospective borrowers must meet to obtain the business loan and keep as a covenant of the loan.

3. Owner Guarantee

I am guessing you listed collateral before the owner guarantee. But really, don’t you simply want to get paid, on time, as agree? If the owner needs to re-inject some capital or cut back on compensation to make that happen, I am okay with that. By looking at the financial strength of the borrower, you have a better idea if they can step in if needed.

This requires you actually look at their financial strength. I am concerned about the number of lenders willing to use k-1 information for cash flow from unrelated business entities rather than requiring the underlying entity tax returns. The argument I get is that the unrelated business, if not guaranteeing the loan, is not obligated to distribute more to the owner when your business borrower needs a capital injection.

I get that, but look at it this way. I want to see the source returns for unrelated pass-through entities, not because I can force them to pay, but to gauge reliability of the k-1 distributions I am counting. It is about how solid the guarantors cash flow stream is, not about who else is on the hook.

4. Collateral

Finally, I want to know what I can get if I sell the collateral. But really, I don’t want to. This is a business loan, not a collateral purchase, right? That is why this comes in fourth.

Do you have a business loan repayment source I missed?

What am I missing? Where would you put it in the list?

About the Author
Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis. She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans. Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.