Say "Yes" to Good Loans


Thoughts and resources on lending to businesses and business owners.

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Guarantee a Loan

The reason small to mid-size business owners often incorporate is to limit liability but one way they can lose that is to guarantee debt.

Maybe that is not a failure because they did it on purpose but they certainly need to understand that at least for that loan or that contract they are now openly liable personally for that obligation.

Get sloppy...

The second is they get sloppy. I am the President of my corporation and when I sign any legal document it is Linda Keith, President, Linda Keith CPA Incorporated. If you get sloppy and start signing it personally, you might be personally liable.

Failure to pay payroll taxes

The last one might be a surprise and that is unpaid payroll taxes. Payroll taxes, at least in part, are withheld from the employee. They are held in trust until they are turned over to the federal government. So failure to pay payroll taxes isn't just not paying your own expenses, but it is not turning over a liability that you incurred the moment you withheld it.

It doesn't do you any good if you are an officer who delegates that responsibility to someone else.  You may still personally be on the hook for any unpaid payroll taxes.

Lenders watch for red flags

In my training on tax return analysis we look at red flags and I'll tell you, underpaid payroll taxes is certainly a red flag from two directions. One is the unpaid tax liability they have incurred because they have not turned that over.  And the second is, if there is a company that can't pay their payroll taxes that is a red flag all by itself.

What business owners need to know

So, owners that are trying to mitigate their risk by limiting liability need to know about these three ways they could fail to limit the liability.

Why One-Owner LLC is better than Sole Proprietor from Linda Keith on Vimeo.

Well, I think so and here is why.

Downside of a sole proprietorship

If a Schedule C is filed by a sole proprietor, what we know is that sole proprietor has unlimited liability with regards to that entity. Anything that goes wrong can come back against them and their personal net worth or any other activities they are involved in.

How can you tell it is an LLC

If when you look at the Schedule C or F it has the name of the company and LLC after it, this means it is a one owner Limited Liability Company. That means that unless they have personally guaranteed debt, they have limited liability should something go wrong in the business.

Here is what that actually tells me.

Getting professional advice...and taking it

Number one, they probably got professional advice because just in general people will do the simplest thing. If it is a small business just start a sole proprietorship.

If they have started an LLC, someone has advised them to do so in order to mitigate risk. Which means the owner is taking steps, active steps, to mitigate risk. Not only did they get professional advice, they took it.

Risk mitigation is a good thing

So I would rather see a one-owner LLC than a sole proprietorship on a Schedule C or a Schedule F. It tells me the owner is mitigating risk, has professional advisers and actually takes some of their advice.

I had a great time in an interview with Meredith Elliot Powell on her talk show, 'The Client Connection'. If you want to make more good loans, if you want to find, capture and retain the most profitable customers, take a few minutes to watch this webinar.

October 15th through 18th

A new type of event for Linda Keith CPA Inc! We are sponsoring the Better Banking Summit.

I know people!

Not too long ago I realized I know so many experts in different aspects of banking that we ought to just get together and take care of our, and each others, clients! At the free, online Summit, we each will share some of our best ideas on Leadership in your Bank or Credit Union, Loan Quality and Credit Management and Building the Bank or Credit Union through Rainmaking Strategies, Referrability and Qualities of Top Performers.

My business reading this morning ran across the same statement from unrelated sources.

Owners working 'in' or 'on' the business

An interview with Michael Gerber of 'E-Myth' fame reminds business owners that they need to work 'on' their business, not just 'in' their business. I had heard that before and despite mostly working 'in' my business, I do raise my head up frequently and work 'on' my business, too.

But when I read that same phrase again within hours, I decided there must be a reason.

Business has been bumpy during the recession. But truthfully, almost every business, in any economy, has undergone many twists and turns.

When bankers analyze  tax returns to make the best loan decision, you are always looking for clues to whether the business is successful, will become successful, or regain success. It helps to remember that even in a great economy, the road to success is not paved. Bumps. Twists. Breakthroughs. Turns. Stumbles. Breakthroughs.

Frank Coker of Corelytics brought this article to my attention and it sure rang true with me. If you have a business borrower in a rough patch, it might be the economy. Or it might just be business as usual!

Enjoy! And then tell me what you think.

The Forgotten Secrets Of The Enterprise Giants: Virality, Word Of Mouth, And Other Radical Experiments

I am always on the lookout for concepts and tools that help businesses and their lenders evaluate how they are doing. And with my emphasis on cashflow analysis of tax returns for lending decisions, cashflow and cash management are subjects dear to my heart.

I found this blog-post by Frank Coker of Corelytics, a company that provides a financial dashboard for business management to support good decision-making.

The Art of Cash Management

In it Frank makes the case for moving from a tactical approach common to most small businesses (can I pay my bills next month) to a strategic approach to have sufficient cash to pay bills, grow the business, and withstand short-term challenges.

What is wrong with tactical?

Admittedly, during the recession, I narrowed my focus to tactical. At one point we updated our six-week cashflow on a weekly basis to stay on top of cash needs. Happily, as my business has recovered to pre-recession levels and better, i no longer have to take that short-term tactical focus and am expanding back into a more strategic approach.

Is selling the business an important part of your borrower/guarantor's plans?

Then a strategic approach to cash management is a critical component. As the business lender, do you know which approach your business borrower/guarantor is taking?

This post is generalized from an agblog, Farm CPA Today, by Paul Neiffer. Paul is a CPA with an ag background and serving the agricultural community in central Washington.

While his post is titled "Are You Ready for the Super Bowl of Farming?" the suggestions he makes to farmers to be sure their businesses are play-off ready could apply to many types of businesses.

So consider this checklist of 'best practices' for any business and see how your business clients measure up. I have put in {brackets} the places to substitute the appropriate wording or practices for the type of business you lend to.

As a manager of your {farm operation} are you:

  • Using accrual accounting to determine your true {net farm} income for each year
  • Taking advantage of {precision farming} to minimize your input costs and maximize your revenues
  • Using a marketing plan each year for each {crop}
  • Maximizing your equipment utilization to reduce your overall equipment cost {per acre}
  • Providing appropriate incentives for your employees
  • Taking advantage of a Web Site to provide information to your landlords, employees and other interested parties
  • Being proactive with you banker by providing information before they ask and keeping them updated
  • Obtaining education each year on how to improve each of the above items.

If you are an ag lender, take a look at Paul's blog. Understanding the business and tax side of agriculture will improve your lending knowledge-base.

What blogs or online resources do you use to keep abreast of business and business lending issues?

With a small to medium size business, you are likely to find the company has chosen the cash basis of accounting. While this choice actually gives you a better sense of cash flow, it can be misleading in understanding how profitable the company really was.

First, some background:

Cash basis: 

  • Record income when received
  • Record expenses when paid
  • Advantage...the borrower defers taxes if the company receives the funds after they are earned and it overlaps the year-end.
  • Advantage...this type of accounting is easy to do (checkbook and throw in some depreciation) so a very small business without an outside CPA can easily do their accounting themselves.
  • Advantage...the borrower has some ability to impact the tax level by year-end acceleration of expenses or deferral of revenue.
  • Disadvantage...the borrower pays taxes early if the company receives the funds before they are earned (a deposit) and it overlaps the year-end.
  • Disadvantage...the tax return can be very misleading when their lender is using it to determine credit-worthiness.
Accrual basis:
  • Income is recorded when earned. (Earned but not received shows up on the Balance Sheet as an asset: Accounts Receivable. Received but not earned shows up on the Balance Sheet as a liability: Deferred Revenue.)
  • Expenses are recorded when incurred. (Incurred but not paid shows up on the Balance Sheet as a liability: Accounts Payable. Paid but not incurred shows up on the Balance Sheet as an asset: Prepaid Expenses.)
  • Advantages and disadvantages when it comes to tax returns? Just reverse the ones noted in the cash basis section above.
What is a lender to do?
  • You do not get to choose whether your borrower provides cash basis or accrual basis tax returns. And with a small- to medium-size business, you may not have influence on whether the financial statements they provide are on cash basis versus accrual basis.
  • In the overview stage of analyzing the borrower's tax return (see my business tax manuals, page one of each type of return for the overview list) note whether the return is cash-basis or accrual-basis before you compare the years.
  • If your software calculates accrual adjustments (most of my Ag Lending clients do) leave them in if cash-basis but zero them out if the tax return is already accrual basis.
  • If you have the tax return for anything other than a sole proprietor or one owner LLC you may have the balance sheets per books in the tax return. (There is an exception of the company is small enough.) If the tax return is on the cash basis and the books are on accrual basis you'll spot the accounts receivable and/or accounts payable. And if you know how, you can then convert the income statement (front page of the tax return) from cash to accrual.

So to answer the question, no...cash-basis on a tax return is not a red flag.


Resources:

For a full explanation of cash vs accrual basis and the formula for conversion see Pages 2-5 through 2-7 in the self-study manual: Understanding the Business Scorecard: Financial Statement Analysis. 

For the overview list (including the tip to check on cash or accrual basis) for the 1065, 1120 and 1120S returns see Pages 2-9, 3-13 and 4-13 in the self-study manual: Beyond the 1040: Corporation, Partnership and LLC Tax Return Analysis.

Brian Hamilton, President of Sageworks Loan Analysis Software, will be addressing FDIC examiners in a few days about global cash flow. He asked for my thoughts about lender/analyst's typical questions, trickiest questions and what examiners should be asking about global cash flow in your financial institution.

So here is part one...a typical question on global cash flow.

Why do I need global cash flow if I can qualify the business borrower with the business information alone...or the owner with just their personal cash flow from the business?


Some lenders still think it is okay to qualify a business borrower with just the business information and that the personal information is not needed if the business looks good.

Or if they agree they need the personal as well to look at a guarantor analysis, they think it is okay to skip the additional businesses owned by one or more of the guarantors as soon as they get 'enough' cash flow.

They may be applying the idea that you can do a consumer loan based on just the 'borrower' and leave out the 'co-borrower' if you don't need the additional cash flow to qualify.

Those lender/analysts sometimes fail to see that the risk of loss is as or more important to pulling everything together for global cash flow as is the possibility they can find more income.

The answer...if a source of cash flow is significant to the borrower's overall ability to pay or if there is a significant risk of loss, it is important to include it in the analysis. Whether you do that through a global cash flow process or piecemeal, you have to do it.