Financial institutions use Global Cash Flow analysis (GCF) to evaluate the risk involved in group lending based upon the collective cash flow of the group obtaining a loan. When sourcing financing, you should be aware of some common errors encountered in GCF analysis. Mistakes such as these can cause a loan request to be denied and so care must be taken to avoid them.
1. Failure to combine business and personal financial statements into a single cash flow statement.
Technically, such a mistake would not even qualify the end result as a GCF analysis; however, it does occur. In the event that this problem arises, the resulting GCF will be distorted. Therefore, it is important to assess all of the demands on all cash flow in order to determine the likelihood that the borrowing entity may experience problems repaying the loan, or possibly even enter into default. Simply gathering and evaluating the financial information of all of the individuals and groups participating does not mean that a GCF analysis has been performed; the information must be evaluated as a whole, and included as such into a proper GCF analysis. A truly global analysis combines all personal and business financial statements into a single GCF. When reviewing a GCF, always remember to look for the “net” in net cash flow.
2. Failure to recognize ‘double-counted’ income.
In the process of avoiding the first mistake, a common oversight that the inexperienced analyst makes is in double-counting income. This usually happens when an analyst fails to deduct distributions to shareholders when giving a borrower credit for EBITDA. This problem can then be exaggerated if a shareholder or guarantor is given full credit for earnings instead of distributions on 1040 Schedule E part II. In the event that a shareholder’s K-1 earnings are added to that, the problem is intensified even further. Cases like this highlight the need for accuracy and attention to detail when calculating GCF. Fortunately, correcting this type of error is generally a simple procedure; noticing double-counted income is the real issue. By following accepted accounting principles, the vigilant financier can easily recognize when this problem has occurred.
3. Failure to use the appropriate tax forms.
Proper GCF analysis relies on tax returns, and their supporting schedules, to determine the outcome. Since a comprehensive and accurate picture is what a GCF seeks to provide, the necessary documents can include anything from simple individual returns to combining multiple partnership with corporate tax returns in order to get a true picture of GCF. For instance, K-1 forms, used to report a partner/shareholder’s distributed share of income, are critical in revealing relevant individual distributions and contributions. Without these, a true picture of cash flow cannot be established, and in such cases, the accuracy of cash flow can be questioned based on the reliability of using paper transactions which have no relation to real cash flow. When GCF miscalculations are made due to the omission of the appropriate tax forms and other financial information, serious doubts are raised which call into question a borrower’s ability to service the debt. Thoroughness is key to verifying that all requisite tax forms have been included in preparing a GCF analysis.
4. Failure to be consistent when performing GCF analysis.
In order to remain consistent, one needs to make sure that they consistently use the same procedure to calculate GCF. To do otherwise will produce deviations in GCF analysis which leads to unreliable risk management and unstable pricing. In addition, regulators are keen on locating inconsistencies, and once they notice these red flags, they will continue to scrutinize further; possibly resulting in significant financial loss for the offending institution.
For these reasons, a standardized method of conducting GCF analysis, based upon sound accounting principles, must be implemented in order to prevent errors of inconsistency. Spreadsheets are often found to be the source of such variances; therefore, creating a uniform spreadsheet is a key step in eliminating discrepancies. Familiarity with the policies of the organization conducting a GCF analysis is critical in sourcing financing.