5 Common Errors in Global Cash Flow Analysis
For banks and credit unions, the term “borrower” can often take on many meanings, especially in complex situations where the “borrower” can have multiple owners, businesses, real estate entities and/or farms. When combining personal financial information, the analysis can get even more complex.
To more objectively calculate a global risk assessment of the borrower, institutions often perform a global cash flow analysis. This provides a more holistic (“global”) view of the cash flow available to meet debt service obligations. Institutions that don’t perform a global cash flow analysis correctly – or at all – face several risks, including pricing loans incorrectly, making incorrect loan decisions, or overstating cash position, debt or income.
While there are several global cash flow best practices, banks and credit unions often make these five errors when performing a global cash flow analysis:
1. Failing to combine business and personal financials into a single cash flow.
Obtaining and analyzing the cash flow of all of the people and/or businesses isn’t enough – they must be combined into a single cash flow for a global view. Failing to do so opens the door for incorrect analyses, including double-counting of income.
2. Not requesting all the necessary tax forms or financial statements.
By failing to request all documents, the bank or credit union may not have the full picture of the borrower, missing key information on other owners, businesses or properties. This error can be mitigated by ensuring the loan policy includes guidelines for when which documents are to be collected.
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3. Inconsistency in applying a global cash flow analysis.
It is critical that the loan policy also outlines the process for when and how to use a global cash flow analysis. Two common scenarios when an institution will require a global analysis are (1) small businesses where owner income and debt will significantly impact the business and (2) real estate investment situations where there may be many properties involved with overlapping assets and liens. Using an automated credit analysis solution can also increase consistency among employees.
4. Low-quality financial information.
In order to make an accurate decision on a loan, high quality, consistent data is needed. For new or larger entities, getting validated projections of expected business performance based on similar businesses is recommended. For more complex loans, institutions should require CPA-reviewed financial statements prepared in accordance with GAAP. For less complex loans, institutions may be satisfied with tax returns from the borrower and principal and personal financial statements.
5. Incorrect use of debt service coverage ratio (DSCR).
Banks and credit unions often use DSCR when performing global cash flow analysis, but there’s often confusion on when to use an average DSCR or most recent. While there is no one, right way, the following methods are generally accepted:
- If there is no DSCR trend, use the average.
- If DSCR is improving, use the average to account for cyclicality.
- If DSCR is deteriorating, use the most recent value.
For more tips and best practices on performing global cash flow analysis, download the Definitive Guide to Global Cash Flow Analysis.