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Larry’s Debt Repayment Strategies, Inc.

Posted on June 26th, 2016

Jack Kern
Outsourced Accounting Department, Inc.

In my previous article, Larry’s Funding Strategies, Inc.,” I demonstrated another way of looking at cash flow, by expressing it in terms of borrowing availability against accounts receivable in order to fund sales growth. I now would like to take another look at what was happening to the company’s ability to repay its debt on more of a “micro” (monthly) level. This is an extremely important issue, not only in how lenders analyze your financial statements, but more importantly, how you as the business owner manage your cash (or don’t).

In that previous scenario, the final outcome was a good one, because Larry planned ahead and was able to obtain outside financing to support the company’s sales growth before it occurred.  But let’s now take a look at what was going on behind the scenes:

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Note first on the company’s Projected Income Statement its operating losses during the first 6 months of the year.  Then look at the Monthly Cash Flow Statement and notice its negative cash flow before debt service (“Cash / Operations & Financing” line).

Now, also look at the “Financial Highlights and Ratios” on the last page, the “Cash Flow From Operations” and “Debt Service Coverage” lines. These negative numbers are further indicators that the company’s Cash Flow From Operations (in month 1, net loss of $18,946 plus depreciation of $48 = $18,898 in the numerator) obviously cannot service the company’s principal payments on long term debt ($1,105 in month one on Monthly Cash Flow Statement in the denominator).  Rather, the loan payments just add to its cash deficit each month.  Thus, due to it’s operating losses, combined with sales (receivable) growth, and various other cash drains, had it not been for its starting cash position (which is quickly depleted when the owner paid himself back in month 2), followed by advances under its new line of credit, the company would not have been able to meet its payment obligations on long-term-debt.

This issue is critical for a couple of reasons, one being that in effect, this company is borrowing money to meet its debt service obligations (i.e., “robbing Peter to pay Paul”), a big “no-no” in a traditional bank lending environment. The other reason is that most banks typically don’t like to lend money against accounts receivable if that is their only collateral. This is because unless the bank has absolute control over the company’s receivables, those receivables can quickly be diverted by the owner to other uses – including, but not limited to him or herself, or funding the company’s operating losses until it’s out of business and the bank has no more collateral. This is why there exists specialized lenders such as “asset-based” (accounts receivable and inventory) lenders and factors, a much more expensive form of financing than banks, but they serve a legitimate purpose.

Here again, the critical role of “profit” cannot be emphasized enough. As demonstrated above, ultimately, it’s what must fund the company’s debt service requirements among many other things, and to ignore this reality is why some companies go bankrupt.


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