The Author – Stephen Bartoletti

Tools for Efficient & Effective Commercial Lending

SME commercial lenders are always under pressure to be efficient and effective. The tools that I developed for my own efficiency as a commercial banker in California continued to evolve in my second career as a development banker, when I used them to supervise banks in emerging markets.

Teaching and writing about the tools led to a simplified approach to the analysis of cash flow, but with some spectacular, paradigm shifting revelations. Here is my history and the evolution of some practical credit tools.

California (1980s) “The Four Legged Chair” 

As a junior lender in California, I saw a pattern as to which of my loan proposals were declined.  As a more senior lender, I taught the credit courses for the bank’s junior lenders and shared with them this practical observation: “Theory aside, if your loans are declined, it will be for one of these four reasons…”

  • Unreliable Profitability
  • Insufficient Equity (measured by financial leverage)
  • Insufficient Collateral
  • Absence of Owners’ Guarantees 

I originally called these “the Four Hurdles;” but later named the model: “the Four-Legged Chair.”

Bulgaria  (1992-1994)   “The First Hurdle Analysis”   

The Soviet Union had collapsed. Wanting to participate in the historic change, my wife and I joined the Peace Corps. Capitalism had suddenly replaced the defunct centrally-planned economy, and former communist bankers had to learn the most critical concepts and tools immediately.  I condensed the two-year course that I taught in California into a one-week seminar (“Credit in a Free Market”) by isolating the critical points and presenting them in two practical models that comprise the First Hurdle Analysis.

The First Hurdle Analysis is a methodology that first applies the principles of the 4-Legged Chair to assess general creditworthiness; then, if the borrower appears to be creditworthy, turns to a second model (originally called the “Time-Balance Balance Sheet”) to determine the right amount of credit and the right structure.

Russia (1996)  “The First Hurdle Analysis” is validated

The First Hurdle Analysis proved to be an effective screening tool in 1996 when my Russian staff and I used it to supervise the Enterprise Support Project (ESP).  ESP was a $300,000,000 credit facility joint-funded by the World Bank and the European Bank for Reconstruction & Development (EBRD) to initiate loans to SMEs through a dozen Russian banks. This intense usage confirmed the efficiency of the First Hurdle Analysis, as well as the academic integrity of the two underlying models.  And the First Hurdle Analysis is so logical that it facilitated discussion about loan requests between my staff, the bankers, and their SME borrowers – where many were new to credit principles.

I continued to refine the tools for several years while supervising credit lines granted by the World Bank to commercial banks in East Europe and Central Asia.

Malta (2010) “The Cash Cycle Balance Sheet” — Cycle-Based Cash Flow

In between consulting assignments, I began work on a book for junior lenders (relaxing on a sunny Mediterranean island is conducive to creative thinking!).  I was striving to provide an academic explanation for the traditional paradigm for structuring credits: short-term loans finance short-life assets, long-term loans provide cash for fixed assets.

Light bulbs began to light up:

1.   Cash flows in cycles: funds from investors (creditors & owners) are invested into assets; the assets, in turn, generate cash flow to repay the investors.

2.   There are two cycles because there are two kinds of assets which generate cash flow in fundamentally different ways.  Accounting convention validates this: assets and liabilities are divided into short term and long term (fixed).  What about equity?

3.   If we divide equity into working capital and fixed capitalthe division of the balance sheet into a short-term balance sheet and a long-term balance sheet is complete. Moreover, the two balance sheets depict the two cash flow cycles!

In January 2011, with the addition of “fixed capital,” the “Time-Balance Balance Sheet” matured into the Cash Cycle Balance Sheet. 

So far, this was innocuous, but one revelation led to another and began to challenge convention. The two most heretical discoveries are: 

4.   The time-honored measures for working capital and the current ratio are flawed, distorted by including CPLTD in the current liabilities.  The missing piece—the Current Portion of Fixed Assets (CPFA)—should lead to a change in FAS/IFRC financial reporting and change the way working capital and the current ratio are calculated.

5.   The notion of cash flow cycles was lost with the advent of FAS95 and the UCA Cash Flow Statement.  Like the formulas for working capital and the current ratio, The Cash Flow Statement fails to warn when a company is illiquid, unable to repay its short-term debt, and gives false assurances as to long-term debt-repayment when the apparent strength is stems from poor credit structure: excessive short-term debt and not enough long-term debt.

There is much more:  Cycle-theory brings other new insights when we consider the intersection of the two cycles and explore how cash flows between the cycles. The dominoes continued to fall, one discovery leading to another, each a new chapter, developing into a book. The complete framework for “cycle-based” cash flow theory was first published in 2013 in the book: Cash Flow 3.0.

2021  Cash Flow Lending

Almost a decade later, following years of academic discussion, the original book Cash Flow 3.0 was enhanced and replaced by Cash Flow Lending—Principles based on Sustainable Cycles, published in 2021  (see tab Cash Flow Book).