April 2011 Archives


Here is how you end up with Interest from a Schedule K-1 on 1040 Schedule B:

  • Schedule B includes all taxable income.
  • Interest income received by an S Corporation or a 1065-filing entity like an LLC or partnership is passed through and taxed to the owner of the company
  • Thus interest not received by an individual will be listed on Schedule B
This is another example, once again, that taxable income is not necessarily cashflow.

What do you count?

My favorite answer...and if you are a regular reader of my blogs or have attended my training for lenders and underwriters on Tax Return Analysis...you know what is coming! It depends.

My approach

I do not include Schedule K-1 Interest in personal cashflow. The 1040 filer did not receive that cashflow. It does not mean they did not receive ANY cashflow from the company. But if they did, we'll find what they actually received on their K-1.

The K-1 is a schedule of the 1120S or 1065, not the 1040. So you won't have it unless you ask for it.

It still depends

With a lower % owner, of if you only want to consider actual cashflow from the company to the owner/guarantor, obtain the K-1 and cashflow that. Don't know what to use? Time to come to class, take the Business Tax Return Analysis series of nine eCourses at www.LendersOnlineTraining.com, or order the manual.

Okay, you could also do a site-wide search of this site and find the answer. But if you are a lender, underwriter or analyst -- for a bank or credit union or creditor -- and you have that question, you have other important questions that need a more extensive review of tax return analysis.

With a higher % owner who has control over what she takes from the business, you might prefer to use cashflow available from the company instead of what she took the last couple of years. Obtain the full 1120s or 1065, determine company cashflow, and then give her credit for her share. This is where interest income received by the company will come in.

How low is low and how high is high?

Most lenders provide a guideline for determining whether you request only the K-1 or the entire tax return. Residential mortgage lenders often use a 25% threshold. SBA lenders often use a 20% threshold. I've seen as low as 10% and as high as 51%.

Check your guidelines to decide.

Common sense and judgment

Also consider what type of flexibility you are expected to exercise in the area of judgment and common sense. Are your guidelines more 'guide' or more 'lines in the sand'. Even if the borrower owns less than 25%, if you know the underlying company is in trouble should you consider that? I can't tell you the answer but you need to find out.
I just published the latest eCourse at www.LendersOnlineTraining.com. I know that some small business owners sign up for the Lender's courses to see what the lender wants. This would be a good one!

Here is my short list:

  • Cover page...sizzle optional
  • General info including details on source and use of funds
  • Company info including history and management
  • Marketing info including brochures, website screen shots, info on market share and competitors
  • Financial info including projections and recent financials
The eCourse on Loan Proposals can be purchased a la carte or as part of the subscription to the entire eCourse List of over 30 courses. Check out the entire list of online credit courses for lenders.

Clues the lender doesn't want to miss

  • The extent of the business owners marketing and financial knowledge about their business can either give the lender confidence or give her the willies!
  • Typos and grammatical errors in the loan proposal may be an inside window into the sloppy way the company does business with their customers

Surprise!

Here are a few surprises a lender might like to see:

  • Updated loan proposal even if the business lender did not ask
  • Information previously provided has been updated for newer information
  • If financial projections are included, what is the thinking behind it?
  • Independent information that backs the proposal up, such as from the local Economic Development Council
  • An honest and forthright description of recent challenges in the business, actions taken, results and adjustments.

Give 'em a break

If the loan proposal seems overly thick, give the business owner a break. Some lenders take the 'thud factor' (the sheer weight of the proposal) into account so more pages seems the norm these days. Besides, business borrowers may be nervous with what they've heard about the scarcity of business loans. They may think more is better!
Every year I teach Junior Achievement classes in elementary schools. It does not matter how busy I am with 'teaching' business owners and lending professionals. I take time out because it is the right thing to do and I hope you will, too.

It is encouraging!

These kids get it. Sometime between the common sense of a ten year old and the adult years, something gets lost.

Example: The JA book defined a Resource as something people need. One of the students, Max, suggested it should define a Resource as something people need or want. I had to agree!

Planning a business...

The students were given about five minutes to come up with a business they might start:
  • Business name
  • Type of business
  • Good or service
  • Natural resources they might need
  • Human resources they might need
  • Capital resources they might need
They struggled with this assignment, particularly in the short time frame. When time was up I asked if it was hard. Their discouraged faces told the story. Yes, it was hard.

I told them it should be. That starting a business is hard. That there are a lot of questions to ask before they start. But that every business started just the way they started a few minutes ago, with an idea and a start on the questions.

Time for business owners to (re)ask questions...

Perhaps business owners (and maybe their lenders) should ask questions again. The disruption of the recession calls for it.
  • What business are they in?
  • What has changed for their customers and what has remained the same?
  • What resources do they need?
  • Who can help them answer the questions?
Some business owners never asked the questions in the first place. And most of us need to ask them again.

What questions would you add to the list?