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Assessing Global Cash Flow Post Pandemic

May 11, 2021
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The What, When, and How of Global Cash Flow

While many institutions have already implemented global cash flow, are they using it effectively in the post-pandemic world?

You might also like this webinar on assessing global cash flow.


The What

What is global cash flow?

The coronavirus pandemic has made understanding business relationships and credit quality increasingly difficult for financial institutions. Not only has the pandemic impacted businesses by shortening operating hours or closing businesses altogether, but it has introduced stimulus money that those same businesses have come to rely on as part of their cash flow, creating new challenges to testing the creditworthiness of prospective borrowers.

Global cash flow (GCF) analysis can help institutions better assess credit and lending decisions by considering the combined cash flow of a group of people or entities to get a holistic picture of their ability to service a proposed debt. The GCF analysis is performed during the initial loan underwriting or during an annual review. In a recent Abrigo webinar, Rob Newberry, Senior Advisor with Abrigo Advisory Services, stated that the purpose of using global cash flow analysis is to “uncover additional rocks that might be there trying to trip us up if we’re not careful” when determining an applicant’s creditworthiness.

The When

When to use GCF at your institution

Many financial institutions use global cash flow analysis in their lending process. In an informal poll during the webinar, attendees were asked about their effectiveness creating and utilizing global cash flow analysis in the lending process. Nearly nine out of 10 respondents (87%) reported using GCF, with 44% of respondents saying that they are proficient in the use of global cash flow, while another 43% said they continue to improve in creating and using GCF.

In many cases, financial institutions will leverage global cash flow analysis if a borrower has complex credits with multiple related business entities, or when there are concerns with the commingling of funds with a single entity and personal financials. Financial institutions should ask two questions before looking at a global cash flow analysis: Why do examiners want you do to global cash flow analysis, and could the borrower’s credit risk improve by looking globally?

“[Examiners] want to understand what potential risk is out there within the bigger scheme of things,” Newberry explained. The more complex the borrower is, the more risk is involved with the relationship. The financial institution must understand the stability of the sole company of which they have a relationship. If the borrower defaults and the institution has no legal recourse to get the funds from its other entities, should they be included in the global cash flow analysis?

A common misstep seen in lending departments is the belief that a guarantor improves an applicant’s credit quality. “When we combine borrower financials with the guarantor’s, to improve the ratio analysis…we’re really double-counting the guarantor’s value to some extent,” said Newberry. Financial institutions should assess whether the entity could stand on its own without the guarantor. Is the guarantor able to supply funds to meet those obligations if the loan goes bad? If the borrower’s financials are not good on their own, then the financial institution is strongly advised to decline the loan or have the guarantor become a co-signer.

“When we combine borrower financials with the guarantor’s to improve the ratio analysis…we’re really double-counting the guarantor’s value to some extent,” said Newberry.

The How

How to properly use GCF

Running a global cash flow analysis requires combining a borrower’s personal and business financials to see their total cash flow. An institution can look at their debt-to-income (DTI) ratio, which does not count for living expenses or taxes, or their debt service coverage (DSC) ratio, which is generally the net of their living expenses and taxes. Whichever method they use, it should be the same across the institution so that they can get a factual comparison. Institutions also need to choose what type of DSC ratio to use, either an average over a specified time period(i.e., three years) or the weighted average over a specific time period (i.e., 20/30/50 split over three years).

Dive into the what, when, why, and how of global cash flow.

Watch the webinar
Pandemic Problem

The impact of Covid-19 on GCF

Institutions should also look at the impact the COVID-19 pandemic and the subsequent relief efforts have had on the business. Is it a nail salon in a strip mall that was required to be closed for most of the last year or a restaurant or hotel working under limited capacity?  Is it an online business that has seen little disruption from the pandemic?

In addition to changing business operations, institutions should also consider the influx of stimulus money businesses and individuals have received over the past year. Most businesses had access to Paycheck Protection Program (PPP) funds intended to help small businesses stay afloat and keep workers on the payroll. The government also issued multiple rounds of stimulus checks to help citizens with potential wages lost due to the pandemic. Are these funds being included in a borrower’s financials? It is important to look at the bigger picture of the cash flow generated from standard business operations versus stimulus money that is not recurring.

Regulators also eased troubled debt restructurings (TDRs) in 2020 due to the pandemic, giving lenders greater flexibility to offer payment deferrals and loan modifications to borrowers. If a borrower relied on either of those over the past year to stay afloat, it might be time to run a global cash flow analysis on their annual review.

Effectively Use GCF

Best practices for implementing GCF

There are a lot of things to take into consideration when applying global cash flow analysis, and the coronavirus pandemic has expanded these considerations. To effectively use GCF analysis and make safe and sound loans, refer to these best practices :

  • When combining business and personal financials, be certain that you are not double-counting cash flows from the comingling of two entities. Double-counting revenue can overstate a borrower’s cash flow or DTS coverage ratio to make the loan look better than it is.
  • Assume lines of credit are fully drawn so you can account for the worst case scenario Assume that more than the minimum payment is being made on credit card payments
  • Deduct a living expense percentage of the individual’s salary (15-20% is a common guideline)
  • Use K-1s instead of investment income reported on the 1040E part II

Financial institutions should ensure all analysts use the same methodology for calculating GCF. Analysts should be comparing apples to apples to get a clear picture across the board for the institution. Be sure to request all the tax forms and financial statements needed from the individual or business, including multiple-partnership and corporate tax returns, business financial statements, and individual tax returns, and remove overlapping cash flows in the global analysis and update and follow your loan policy on GCF analysis.

A global cash flow analysis can provide greater insight into the total cash flow picture of a potential borrower, if it is done correctly and consistently. Implementing a global cash flow analysis is a great time to review your internal loan policy to require tax returns and personal financial statements that you may not have collected in the past. No matter which method you use for GCF, make sure everyone at your institution is doing it the same way to get the best comparison value.

Stay up to date on global cash flow and other lending trends.

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