By Parag Nevatia
Most of us have heard of the phrase cash flow. While some know the meaning, others don’t, but they use it all the time because it sounds great. For those who don’t, let’s look into what it means. There are basically two instances when this term comes up. First is when the business is on-going or existing, it’s referred to as historical cash flow and second, when it is a start-up or a new business, then lenders rely on, what’s referred to as, projected cash flow.
Cash flow simply is the ability to pay back a loan adequately or with a reasonable buffer. When this is not thought out completely by the client or their certified public accountnt, that’s when lenders decline loans because the business doesn’t demonstrate that cash flow or the ability to pay back the loan.
Now, CPAs know how to calculate and show a net profit at the bottom of a company’s financials or tax returns and know its significance or impact. My former colleagues from the banking cmmunity may agree that most of the times this is one of the major reasons why we decline loans.
As a former banker and SBA loan officer, I used to go through each line item on tax returns and ask the client or the CPA many questions and hoped to get a reasonably explainable story behind the numbers in order to do my add backs. Funny thing was that most of the time I would ask questions to get back the answers that I knew already. The exercise was usually to check the guarantor’s honesty and character.
The problem most of the time was, neither the client nor their CPA really knew what the bank was looking for, in terms of adequate cash flow, therefore tax returns fell short to show net profit – often carelessly overseen, in my frank opinion! If the CPA had the client’s expansion goals in mind, the CPA and client would hopefully align all ducks in the row to be able to remain bankable, at least from a cash flow perspective.
Ok now let’s switch gears and talk about the other side. Entrepreneurs know money makes money. You have to invest or spend money to make more money. Lights have to be turned on or shelves need to be filled before hoping to make a sale, with no guarantee that all milestones will be hit.
But to accomplish all that, a calculated risk needs to be taken. My point being entrepreneurs should be prepared to show adequate net profits and consequently be prepared to pay higher taxes. If they don’t show the ability to pay back, that application begs for an automatic decline anyway. Therefore people need to understand higher net profits increase tax liability, but show the ability to sustain loan payments. This is a common problem all the time.
It’s as simple as knowing that if you wanted to buy a slice of pizza for $1.75 but had $1, under normal circumstances, you can’t get that slice because you don’t have the ability to pay for it. But if you had $5, you could not only get your slice but do a lot more. Same with cash flow, if you have the ability to pay back and if you have some cash left over, that gives the extra comfort to the lender to approve your loan, at least from a cash flow point of view.
So to recap, showing stronger net profit or cash flow can result in paying higher taxes but if that results in getting more capital or financing, that’s a good thing! I tell people, it’s either you want the money or you don’t and ironically, each business owner controls their own destiny on whether they should be given a loan or not. That is the problem, but they just don’t know it!
After a successful career in Commercial Banking and Lending in the New Jersey-New York region, Parag Nevatiafounded EZ Funding Solutions LLC with a vision and desire to improve the quality of business credit in the market.
Being certified by the National Association of Government Guaranteed Lenders (NAGGL) that governs the SBA Program nationally, he has the advantage of performing credit and risk analysis, developing creative solutions to overcome obstacles and mitigate those risks, structure debt correctly, and then underwrite a project or loan – all upfront, before presenting it to the right lender who has the appetite to finance the project.
Additionally, Parag serves on the Middlesex County Advisory Board of the Small Business Development Corporation at Rutgers University where he conducts monthly seminars and webinars on “Lender Scrutiny.” He also serves on the Middlesex County Regional Chamber of Commerce Ambassador Committee.
Editor’s Note: Read a new article by Parag Nevatia every Thursday.