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Unintended Consequences… are your guidelines getting in your way?

I was reading Scientific American this morning and reminded of the challenge of unintended consequences.

  • Hybrid cars are quiet…a great benefit.
    • But pedestrians cannot hear them coming!
    • The Society of Automotive Engineers has now created a special committee to examine whether hybrid cars should be made more audible for the sake of pedestrians, especially the blind.
  • We have a federal ban on CFCs to conform with the Clean Air Act…good idea.
    • But asthma inhalers use CFCs to deliver life-saving medicine.
      • This was exempt until the drug industry came up with an alternative, HFAs.
      • Now the CFC inhalers will be banned by the end of the year.
    • The HFA version is patented.
      • It will cost three times the cost of the CFC inhalers.
      • 20% of asthma sufferers are uninsured.
      • The CFC inhalers contribute less than 0.1 percent of CFCs released. This was a political decision, not an environmental one.
    • Nicholas Gross, a member of the FDA advisory committee that approved the ban, has publicly regretted the decision and is requesting that the ban be pushed back until 2010, when the first patent expires and a generic version should bring costs down.

Interesting, but what does this have to do with tax return analysis and making loans to businesses?

Well, here is just one example. Say a business owner/guarantor is also a high-percentage owner of pass-through entities like S Corporations, LLCs or Partnerships. Does your guideline have you use the actual K-1 distributions in personal cashflow rather than what it appears the company can afford?

If so, and the owner has been taking home less than the company can afford over the two or three years you are averaging, consider this unintended consequence.

  • An owner who takes every penny and even more than the company can afford will show more personal income and qualify for a higher personal loan or look better as a guarantor.
  • An owner who is more frugal, who leaves more ‘capital’ in his business for a healthier Debt Coverage Ratio, who can live on less than what he can get his hands on…is penalized, qualifies for a smaller personal loan or looks less appealing as a guarantor.

Wouldn’t a more frugal borrower who practices fiscal restraint be a better risk in an unsettling economy? Maybe.

This is why guidelines are just, well, guidelines. What other ways do your guidelines sometimes have unintended consequences?

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, she speaks at banking associations on risk management, lending and director finance topics.