There are many aspects of business that create a company's success, such as a solid business plan and available lines of credit. However, when determining the financial health of a business, cash is king! We've all heard the phrase "cash is king" but what does it really mean when you are applying for a 504 loan?
This phrase refers to a company's ability to have enough cash to cover short-term operations, pay suppliers and service debt. Sources of cash include loans, investors and revenue. Cash from investors and loans come with strings attached – meaning the company must pay that money back plus more. Therefore, the cash inflow that speaks to a business's health is sourced from profits. A company cannot operate for very long without a positive cash flow.
In fact, cash flow, also referred to as capacity, is one of the 5 Cs of Credit. Lenders use a company's capacity to decide whether or not to lend them money, because it is an indicator of a company's ability to repay the loan. The cash flow ratio illustrates the number of times a business's financial obligations are covered by its earnings. A ratio equal to one or more means a company can meet its obligations. A ratio of less than one indicates a company in financial trouble.
If you are in the market for a 504 loan, your cash flow ratio should be a minimum of 1. This means for every $1 of debt there is $1 of cash available to cover it. This is 1:1 coverage. Another term for measuring a company's cash flow is DSCR, debt service coverage ratio. DSCR = (net earnings + depreciation + amortization) / total debt. Like cash flow ratio, a DSCR of greater than one indicates a healthy business.
More businesses fail for lack of cash flow than for lack of profit. A business's profit and loss statement can look completely in the black, but until the payments are received for goods sold, there is no inflow of actual cash. This is why profit and loss statements don't tell the story of a company's capacity. Without cash, the company is dead. Cash truly is king.
Along with the other qualities of credit, capacity is critical to the decision to lend. Community Business Finance will help you identify the information needed to prove your business has the capacity for a 504 loan.
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