When I am teaching about underwriting topics, Allregs makes some guidelines very clear which leaves no room for any grey area.  Then there are those guidelines that are just vague.  They seem almost to have limitless interpretation. Using business funds as cash to close is high up on my list as the “leader of the grey area”!

We all agree “money” is a large driver qualifying borrower.  But what should we do to meet the guidelines when the borrower is using funds that really belong to their business?

Here are the two questions that come to my mind when a borrower wants to use the funds that are in a business account to close a loan(regardless of ownership percentage).

Q1: What affect will pulling that money have on the business?

Just like our personal checking account, just because there is money in the account does not mean we can spend it.  For example, if you look at your bank account the day of payday it is LOADED!  But if you spend every cent in that account, you may suffer negative effects.  For example, late mortgage payments, a very unhappy (and unpaid) day care worker, or your car stays stuck in the shop because your debit card is rejected for that repair they completed.

These are just a few examples of what happens in a personal account which are minor compared to a business account. Can you imagine a business owner who spends the money a customer paid to get his home worked on which included thousands of dollars in materials, and does not finish the job? Or the devastation that could happen to your business if you can’t fund your payroll costs for your employees?

Q2: What will your business partners think?

I am sure business partners are close, but close enough to “give away” essential funds that are needed to run our business.  All this financial risk just so one of my partners can close on his or her home?  I must wonder about that part.  One must consider being generous versus being fiscally irresponsible.

Let’s review the guidelines:

cash flow analysis

Since the guidelines only give us “what” they looking for, I want to offer my suggestions on “how” to most reasonably determine any negative impact on the business.

Step 1
Get a minimum of two months of assets, having only one month simply won’t give you kind of picture of the business’s health.

Step 2
Review and add up both statements and confirm the following:
A – Total cash in
B – Total expenses out

This will give you a gross profit ratio

$16,000 total expenses out (total of both months) divided by $20,000  Cash in  (Total of both months) = 80% expense ratio, which means it has a 20% profit ratio.

Step 3
Compare the expense ratio on the bank statement to the most recent filed tax return. If the business returns show that overall the business has a reasonably matching gross profit ratio, we can now move onto determining any negative impact

Taking the figures above we now have a better understanding of the cash flow.  Now let’s answer the question I posed a few paragraphs ago.

Let’s set up what the loan has for documentation of business funds

Bank Statement One   July 2018 ABC Bank
$70,000 total deposits
$40,000 total withdrawals
$50,000 Final Balance

Bank Statement Two August 2018 ABC Bank

$65,000 total deposits
$30,000 total withdrawals
$85,000 Final Balance

Most recent business returns show company profit is 50 % of every dollar taken in.

Borrower needs $30,000 from the account and is 75% owner of the company

How to deal with question one:
We know the “gross profit” ratio of the company now.  If the amount of funds needed from the account exceeds the gross profit ratio, the math shows this does have a negative impact and therefore does not qualify.  Said another way, how do you spend more than you take in?

Walking through the math

$135,000 total income in both months
$70,000   total expenses out both months
= a 51% profit ratio

So far so good, the profit ratio is in line with the tax returns, on to the next test. Add the funds needed to the “total expense” number

$135,000 total income in both months
$70,000   total expenses out both months
$30,000   cash needed to close
= a 26 % profit ratio

The business has now passed the next test, the amount of funds needed is not showing “overspending” of the account. Since there is still a profit ratio (even though it is much smaller) pulling this money does not appear to cause the company not to pay their bills.

How to deal with question two
My thought process is the borrower should only be allowed to spend what would be paid out later to the borrower.  If the borrower is 75% owner it is not reasonable to think the other owner(s) would just give up their profit for the borrower and allow every last dime to go to the borrower.

To handle this issue, I recommend using the lowest ending balance of the two months, which is July at $50,000 in our example  Take 75% of the that balance ($50,000 x 75% = $37,500) and see that the request to use $30,000 from the account is reasonable and does not appear to have a negative affect on the business.

Since the answer shows the borrower is not “taking” any of the other owner(s) profit, this again seems reasonable.

Final thoughts

Before I wrap this up, these steps are not in any guidelines, the basis for this thought process is from commercial lending.  When a bank is trying to see if they should lend a business money, they do this same type of math (much more detailed) to evaluate cash flow and if the new loan payment will overload the business with debt.

As an underwriter for all these years I had to develop a fair and unbiased way of meeting the agency guidelines.  In my opinion this method only takes a few minutes to complete the math (a good spreadsheet helps) and provides a logical and financially responsible picture of the impact of using these funds.