Why is showing a profit for a business a “bad thing”?

I have met with lots of small businesses over the years and most all of them state the same thing. "I don't show a profit on paper, but my business makes a lot of cash." This is a problem for most banks and any regulated financial institution because they are basically saying they avoid taxes by lying to the IRS.

Small businesses have been trained by fellow businesses and accountants to never show a profit. While this is good advice to avoid taxes, it is horrible if you want to borrow money. The job of an accountant is to minimize your taxable liability by using legal accounting methods. My job as your lender is to look at your cash flow and determine if you can pay your debt.

I am not saying that you should inflate the numbers to increase your taxable income but understand that if you write off every expense known to man, it will effect your ability to borrow. A good rule of thumb is that your net income plus depreciation and interest expense should be a positive number.

Financial institutions calculate debt service coverage and usually have a standard ratio of 1.25 times. A real world example is that if the above income equals $100k and your yearly payments add up to $50k then your DSCR (debt service coverage ratio) would be 2 times. The rationale is that if your DSRC is below 1 then you don't make enough money to pay your bills.

The bottom line is that your lender wants to help your business grow and be profitable but they can only work within the institutions constraints. One of those constraints is that all of the loans they do have to make sense and making a loan to a business that shows a huge loss every year doesn't make sense.

Thank you for taking the time to read my blogs. I am in no way a subject expert and these are simply my opinions. I welcome any thoughts and discussion.