Last week, I did a post about the five "c's" of credit. The first one was Cash Flow
How do you measure cash flow?
For most small businesses all you have to do is take a look at your net income from your Income Statement and add back depreciation ( it is a non cash expense) and you have a preliminary cash flow figure.
Let's assume you have net income of $25K with $5K in depreciation. That gives you about $30,000 in cash flow. You can use this cash flow to pay on debt, pay out to shareholders, invest in equipment, etc.
Let's now assume you want to purchase a piece of equipment for $60,000. On a 36 month loan @ 8%, your payment will be $1,880/month or $22,560/ year.
Based on your historical cash flow, you have 133% ($30,000/$22,560) coverage. Meaning that your existing cash flow can cover the debt service. If this number is less than 100%, it means that your business does not generate enough cash to cover the payments on the debt.
Most banks want a debt service cushion. Usually they'll want to see a ratio of at least 125%.
This is obviously an over simplification of cash flow. However, it gives you an idea as to how a bank will look at your loan request.
As always, if you would like to have someone review a loan request and give you an idea as to where it stands, email me at gtvcpa@gmail.com
Friday, August 31, 2007
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