Debt Servicing: W2 vs Business Owners – Aviation Finance
The lender will calculate all monthly debts, including the expected debt of the new aircraft and the cost of ownership (estimated aircraft expenses). It is then simply a question of dividing its debt by its income. Generally speaking, a lender wants this ratio to be below 45%.
Business owners are assessed similarly in that they must also demonstrate their ability to repay the loan over its full term. But how business owners get paid is also reflected in their overall financial picture. Indeed, many business owners do not pay themselves a salary, but take money from distributions of the company’s retained earnings. Or they can give themselves a smaller salary, supplementing it with distributions.
That’s why, for self-employed or business owner loan applications, lenders focus on covering the individual’s overall debt service. This debt includes all the different business entities in which the individual has ownership or control.
From there, the lender will assess free cash flow or net income. Then they will add depreciation, retroactive interest, retroactive amortization and even any taxes. This gives the lender a better understanding of cash flow. From these total debts, the lender will determine an ability to pay debt service at a level generally 1.25 to 1.35 times higher.
A business owner may want to reject, discount or exclude a K-1, or an entity in which he has a significant stake that shows a loss. For a lender, the losses are as important as the gains. They will want to know how the business owner compensates for this loss, especially in terms of the ability to cover all debts, including the plane loan. In many circumstances, the company will need to be a guarantor for the loan, particularly when it is the main income of the applicant and/or the aircraft is registered with that entity.
For these reasons, a business owner’s financial situation can be much more complicated than that of a W-2 employee. A salaried employee can usually simply submit tax returns with the loan application. A business owner will want to submit financials that a lender can have some degree of confidence in, such as two or three years of CPA-prepared financials, or interims. At a minimum, lenders will require the last two full years of business tax returns and cumulative profit and loss, balance sheet and debt schedule that take into account all debts attached to the business.
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