5 Sources of Cash Flow to Pay Debt: What's your preference?

It clearly takes cash flow to pay down a business loan. There are five places for it to come from in a business:

1. Cash flow from operations
2. Cash flow from selling off assets
3. Cash flow from borrowing money from someone else
4. Cash flow from owner capital contributions
5. Cash flow from running down cash balances

When you consider whether the business can afford the loan they are requesting, look to see if cash flow from operations will cover it. The other four are the back-up plan.

If you already have a loan in play and the cash flow from operations in recent periods has been insufficient, the Statement of Cash Flows can show you where the company is getting the money instead.

Cash flow from selling off assets

This will make a lender nervous. If the company has taken this route, find out if the assets they sold are no longer needed in their current business model. If they are critical to  operations, is the company now leasing the same equipment on an as needed basis? Do they plan to continue this or do they expect to replace the equipment?

Cash flow from borrowing money from someone else

Yikes! This will definitely make a lender nervous. Find out what the company's overall plan is and when they need to pay those loans back. Borrowing long-term to solve short-term operating losses is generally not a good idea. That said, during a downturn the fact that the company borrowed from someone else and kept current on your loan payments might be a plus.

Cash flow from owner capital contributions

If the company is short operating cash flow to pay their debts, this might be the source you as a lender would most like to see. 'Coming to the table' to save the day is a good thing. Of course, you might wonder where the capital contributions came from and if that leaves the owner short personally.

Cash flow from running down cash balances

If the company had excess liquidity this is okay in the short run. The reason to have good liquidity is to have a back-up plan in a downturn. Look to see how much longer the company can do this without leading to a cash shortage.