Cash Generation & Loan Affordability

Increasingly we are seeing lenders use cash generation as the method of judging loan affordability, rather than net profit as has been the case historically.

The question for a lot of businesses is ‘what is the difference’ or ‘what is it’ because net profit shows on your accounts but cash generation doesn’t.

Hold on, we will clarify…

Cash Generation

You raise an invoice, great that is a sale made. Your accounts show a profit but you are yet to get paid. So that is net profit but no cash, yet.

The theory is that you do not use net profit to repay your loan, your loan repayments are made using cash. So no cash means defaulted loan. Lots of cash means loan repaid.

How Does This Work?

Your lender will have a more complex way of working things out, we like to keep it simple. In essence there are a few lines in your accounts which determine whether you have generated any cash or not, these are;

Net Profit

It all starts here. This is the base from which we start to work.

Debtors

Sales made which show on your sales line, they go toward your net profit but are sales for which you are yet to get paid. If you take your debtors figure last year and compare to this year then any increase equates to cash you are owed but not received.

Creditors

These are costs which you have not yet paid. So your accounts show a cost, which reduces net profit. But, you have not yet paid for them so this is more cash you still have. An increase in creditors year on year means you have accumulated more cash.

Depreciation/ Amortisation

This is deducted from your accounts as a cost of business. It is not a cash expenditure. It is a business cost but you have not physically handed over any cash. These lines are added back on.

Loan Repayments

Remember that interest on any loans is a cost in your accounts. The capital repayments do not show on your profit & loss. Look at the balance of loans last year, then compare to this year. Any repayments made need to come off your cash generation figure.

Loan Affordability

Lenders will look at cash generation against the cost of your loan repayments, typically you want to get to your cash generation figure being about 130% of your loan costs.

Loan Affordability – Confused? Don’t Be

If you have lost the will to live by now then relax… We have produced a simple spreadsheet for you to use. Just add the figures from your recent accounts and it will do the rest.

The spreadsheet is simplistic but it works. You could spend hours working out these figures but what we are looking for is a ‘heads up’ on loan affordability, not something only Steven Hawking could understand!

Download the Cash Generation Spreadsheet and use it. Any queries about loan affordability then give us a call on 01293 541333 or contact us via the website here.

By Lime Consultancy