Global Cash Flow: a Worked Example

An owner-managed company's accounts show one part of a family's finances. A director's salary, dividends, drawings, a shareholder current account, rent paid to a property company the same people own: each moves money between pockets under the same control. A company can show strong cover because the borrowing was placed in the owners' names, or weak cover because they pay themselves well. Its own ratio cannot tell those apart.

A guarantee makes this the lender's problem twice over. A personal guarantee is worth what the guarantor could pay after a home mortgage, tax and the household's living costs. And in a bad year the company and the household lean on the same income, so the second way out weakens just as the first one fails.

Three habits keep the table honest. First, count money once. A salary is a cost in the company and income to the owner, so it is correct on both sides, and rent between related entities nets off the same way. A dividend is different: it is paid out of cash the table already holds. Loans between the family's own entities drop out of debt service for the same reason.

Second, count what recurs, and check it against tax returns rather than a statement the owner filled in. Third, count what is not yet due: a guarantee given for a relative's business is a commitment even if nothing is payable today. The term is most used in American lending, and a public supervisory description of it sits in a US handbook for examiners of property lending: required and discretionary cash flows, actual and contingent liabilities, realistic personal costs.

Family trusts need separate handling, especially in New Zealand and Australia, where they often hold the rental property or the shares. The trustees own those assets, so a beneficiary's guarantee does not by itself reach them. A lender may take a guarantee from the trustees, within what the trust deed allows, or leave the trust's income out of the table.

A tree-care contractor, constructed for this page like every figure in it, is owned by a married couple. Its EBITDA of US$1.10m is struck after their salaries of US$200,000 and rent of US$120,000 paid to their own property company. Tax and maintenance capex take US$400,000, its term loans cost US$460,000 a year, and it paid dividends of US$160,000. The property company has outgoings and tax of US$20,000 and a mortgage costing US$110,000 a year. One spouse also earns US$70,000 elsewhere. The household pays US$70,000 of personal tax, spends US$120,000 on living costs, and pays US$100,000 a year on a home loan and car loans.

The company looks stronger alone because the family's other debts sit somewhere else. Across the whole table the surplus is US$210,000, so a fall of about 19% in the company's earnings, before any saving in tax, leaves nothing over. The last line is the common mistake: the dividend is already inside the company's US$700,000, and counting it again lifts cover above the company's own figure. These levels are the example's, not a market norm.

Debt service cover reads one borrower against its own debts. Consolidated accounts combine a parent and its subsidiaries, but they stop at the edge of the group: no household is in them, and a sister company owned personally or through a trust is usually outside them too. A statement of position lists what an owner owns and owes on one date, so a guarantor rich in land can pass it and still have no spare income. Connected exposure is the lender's own total across related borrowers, an amount lent rather than a capacity to pay.

A combined figure can also hide the weakest part, because one entity's surplus may not be available to another. Issue 03 is a dairy family dividing two farms between two successors, where the useful work is to take the group apart and underwrite each piece alone.

DEFINED IN ONE PARAGRAPH → · DEBT SERVICE COVERAGE → · ISSUE 03 · THE SUCCESSION →

The table changes what the lender asks for. If the household relies on dividends the company cannot spare, the facility may limit distributions. If a shareholder loan is being repaid out of company cash, the lender may ask for it to be subordinated. If the owners borrowed personally to put capital into the company, that debt is serviced from their salaries, and a pay cut to rescue the company then becomes a problem on the personal side.

It also tests a guarantee before one is relied on, and again before one is released (personal guarantee release). A guarantor with no surplus adds little capacity to repay, though a lender may still want the guarantee for the commitment it signals. The weak point is information: debts at other lenders appear only if they are disclosed or show on a credit report, and borrowing held through companies may not show at all.