Jaime is evaluating a loan for Fixed Assets. You are aware, by reading the various articles published on www.elanalista.com, that the tool you should use is NET CASH FLOW.
Likewise, you know that the NET CASH FLOW - FCN is obtained as follows:
Operating Profit + Depreciation for the Fiscal Year - Income Tax - Capital and Interest of the current part of the debt assumed to purchase fixed assets.
Balance that must be greater than the current portion of the fixed asset loan that you are evaluating.
However, he is not convinced why he does not also subtract the principal and interest from the current part of the debt assumed for working capital from the FCN.
Jaime's concern is quite common among Credit Analysts and even among Risk Analysts themselves.
To better illustrate the case and explain why the current portion of the working capital loan should not be subtracted from the FCN, we will take the following year-end (could also be annualized) data from a shell company:
Total Sales $.6,798,986
Operating Income $. 262,441
Income Tax $. 60,703
Depreciation for the year $. 157,815
Short-term bank debt $. 420,000
Loan for current working capital $. 300,000
Loan for current fixed assets $. 120,000
NET CASH FLOW $. 239,553
($.262,441 + $.157,815 - $.60,703 - $.120,000)
Current Part of the new Fixed Assets Loan $. 150,000
Where it is observed that the FCN ($.239,553) is 59.70% higher than the Current Share ($.150,000) of the new Fixed Asset Loan that is being evaluated. Margin that would allow the credit to be approved, considering that Credit Institutions usually request coverage of between 30% and 50%, because decisions are made based on historical figures that do not necessarily have to be repeated during the term of the loan.
On the other hand, it is appreciated that in the FCN calculation the $.300,000 of the loan for working capital has not been subtracted. The question is why?
In this regard, I allow myself to answer with another question: What does a company pay for the credit it receives from suppliers? With the FCN? Definitely not!. Vendor credit is paid with the sale of merchandise or the collection of trade accounts receivable!
So: What are bank loans paid for for working capital? Indeed, in the same way! They are paid with the sale of merchandise or the collection of trade accounts receivable! It is not paid with business profits! You don't pay with the FCN!
The FCN, the balance that remains, after covering all costs of sales, operating expenses (deducted depreciation for the year), taxes and debts assumed for the acquisition of fixed assets, is what the business provides for the purchase of new fixed assets.
On the other hand, the Current Assets items (for example: Merchandise and Commercial Accounts Receivable) are those that allow to cover the supplier credit and the loans for working capital. As expected, the Current Assets must be greater than the Current Liabilities.
Finally, responding to Jaime's concern: the tool to measure the payment capacity of a company to cover a fixed asset loan, effectively, is the FCN, which should not be deducted from banks' credit for working capital, since it it is covered by the sale of merchandise and the collection of trade accounts receivable.
