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Tuesday, November 25, 2008

Daily Observation - CASH Flow

Tonight I want to re-examine the word Cash flow. By the way I deliberately capitalized cash flow. Because without cash flow there is no project, simple that's just the way it is today. Where before we could cross-collateralize or pledge additional assets, not any more. No cash no deal. Also what you consider cash flow the lender will definitely reduce that total amount by all their ancillary fees and deductions.

I am going to share with you information from Special Report #5 Understand How Cash Flow is the Number One Determinant if your Loan will be Approved. Get this FREE Report as well as the other nine at loanforbiz.com or getyourloanclosed.com.

What is cash flow?

Cash flow is defined differently depending on what you are acquiring. For example if you are buying a business the cash flow is more aptly called Sellers Discretionary Earnings (money which is left at the end of the month for the seller after all debt service and other expenditures are covered). Actually, business brokers use SDE to determine the selling price of a business, but more about that latter.

If you are purchasing a piece of real estate, then cash flow is that money which is left over after you deduct all your debt service and operating expenses for the property. Once that net amount is determined the lender will allow you a certain percentage of the available cash flow for the new loan. The total dollars that you are lent is ascertained by the calculation known as debt service coverage ratio.

Debt service Coverage ratio is the new loan’s expected annual debt service divided by the current yearly net cash flow. Today more than ever lenders want to know if you have more cash available then is projected to meet your debt obligation.

Another point to ask yourself is…


We are currently working with a client that is purchasing a piece of property knowing today that it is currently a poor investment, but they have information a major thoroughfare will be built through the town, so they are betting on the future value of the property even though today the economics don’t make sense.

So how is cash flow really calculated from the lenders point of view? The lender will calculate cash flow very differently than the prospective borrower. I cannot tell you how many times I have a client demonstrate to me that the project is cash flowing at a 1:1.25 ratio, and the lender comes back with their calculations at 1:105, or even less.

Why such a discrepancy? Who is Right?

The reason for the discrepancy is the lender will add in all expenditures and apply them to the bottom line. The key term in the last sentence is all. All means expenses that don’t appear today on the seller’s cash flow analysis, income and expense statement or even in tax returns.

How can these expenses be applied when they do not appear anywhere?

Again the reason is lenders always look at the worst-case scenario, which is, they have to take the property back due to foreclosure. If the lender has to take the property back they will have marketing, leasing and management expenses to run the property. Most borrowers will reduce or totally eliminate these costs. The buyer’s rational is they are going to do the leasing, and marketing of the property. Borrowers also assert they can perform these duties for a lot less than the cost of a professional manager or management company.

I’m not telling you this to scare you, but to prepare you.

As I mentioned previously Cash Flow is King, We want to make sure that you are accounting for all expenditures. By the way any extraordinary expenses such as a new roof or one time only equipment purchases are not deducted against cash flow as they are one-time non-recurring expenses.

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