Cash Flow and Investors

I am occasionally asked to provide guidance to developers on how best to structure cash flows and how to present the information so that their investors can see what is happening.  Unfortunately, GAAP is somewhat weak in this area so we fall back on good old fashioned sources and uses statements.

Of course, these become a little more challenging when the project has multiple classes of ownership, each with their own return on investment (ROI) expectation.  And they become really hard when the cash flows are no where near expectations.

Naturally, developers don’t turn to the accountant when things are going well – invariably we are asked to weigh in when things are not working as expected.  In the most recent case, the investors are bothered by cash being paid to the developer and they think it should be paid to them.  This is a pretty common theme.

Changing the facts and circumstances a little, lets say you developed a commercial building.  To keep it somewhat simple there are 3 investors and a lender, A, B Developer and Bank.

  • A invested $5,000,000 with a guaranteed 10% return and is supposed to receive the first $500,000 in cash annually after debt service
  • B invested 5,000,000 with a guaranteed 15% return and is scheduled to receive their payment after a $100,000 developer payment to Developer
  • Developer receives their $100,000 payment and then can receive any residual cash
  • The developer predicted about $1.5 Million in annual cash flow after debt service

Cash flow after debt service is $900,000.   Obviously this is somewhat disappointing, especially for B.  According to the accounting,

  • A receives their $500,000
  • Developer receives their $300,000
  • B only receives $250,000 out of their $750,000

B thinks that developer is taking more money than allowed for.  From B’s perspective, Developer received $300K when they should have only received $100K and the other $200,000 belongs to B.

In the course of trying to explain this, we had to dig a little deeper.  We identified that Developer also invoiced for maintenance – $200,000.  The bookkeeper inadvertently recorded it to the wrong account but the damage is done.  B is threatening to sue for failure to perform.

This is where a good sources and uses statement comes in handy.  We were able to lay out how funds came in and how funds went out.  We started from the accrual basis  and created columns to eliminate the various transactions to get to the pure cash in and out.

By identifying how first funds, and then cash, were handled, B was able to understand that the transaction was first recorded incorrectly and second was not a cash transaction.  We actually pointed out that the invoicing for the maintenance was agreed to by the members and could have been paid out as an ordinary business expense but Developer felt it best to try and satisfy B first to the extent possible.  The remaining cash was actually being held onto as a reserve for some defects that were noticed

As powerful as full GAAP statements can be, sometimes it is the simplest statements, like a sources and uses that can make people understand what is actually going on.  Yes, had B read the full financial statement they might have seen what was going on, and yes B could have handled it better than assuming improper behavior on the part of Developer, but the truth is, when you think you are not received your due one tends to see only things from your own perspective.

So the next time you are facing a question over how money and value are coming and going from your activity try a sources and uses statement.  I think you will be surprised how well it might help the situation.

Have a great day.  If you have any questions about this topic or anything else related to business or management, feel free to contact us through our website.  We are here to be of service to you.

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