Cash waterfall

 

A company can be financed with a mix of debt (senior and junior), preferred equity, equity and other types of instruments. Each instrument has its own features and entitles its owner to certain rights and priority of payments.

To organize the distribution of the cash generated by the company, a mechanism is required, this is the cash waterfall. The cash waterfall ensures that each stakeholders receives the cash according to a pre-agreed order.

 

Distribution order

1.  Operating costs: it is essential to pay first the operating costs to ensure that the company keeps running

2. Capital expenditures: even though a company may decide to reduce its capital expenditures, it must pay its suppliers before any stakeholders

3. Debt service (principal + interests): debt holders are senior to the other stakeholders and have priority over the cash flows generated by the company. There can be different tranches of debt with different levels of seniority, in this case senior debt holders have priority over junior debt holders.

4. Corporate tax: you have to pay the tax man at some point if you are making profits, it is junior to debt because in the case the company is short on cash, it is easier to negotiate a delay with the tax administration rather than with the creditors

5.  Preferred equity: it is generally senior only to common equity

6. Common equity: whatever is left after all the previous stakeholders have been paid can be paid to the shareholders of the company.

 

Below is a simplified representation of a cash waterfall:

Excel modeling 

1. Calculate the EBITDA

2. Adjust for any change in Working Capital

3. Reduce the amount available by the value of capital expenditures paid over the period

 

4. Now that you have the amount available for both debt and stock holders, start with debt holders

5. Using the MIN formula, calculate the amount that can be paid to debt holders, it is the minimum between the cash available you have calculated in 4. and the debt service amount

 

6. Calculate the cash available after debt service

7. Pay the mininimum between the corporate tax payable and the cash available calculated in 6. using the MIN formula. If not all tax payable can be paid, postpone it to the next period and create an indicator to highlight that there is a problem

 

8. Calculate the cash available after corporate tax payment

9. Pay the mininimum between the preferred equity dividend and the cash available calculated in 8. using the MIN formula. If not all the preferred equity diviend can be paid, check the preferred equity documentation to model the consequences (unpaid part added to preferred equity value, accelerated repayment, etc)

 

10. Calculate the cash available after preferred equity dividend payment

11.  Pay the mininimum between the shareholder loan service and the cash available calculated in 10 using the MIN formula. If not all the preferred equity diviend can be paid, check the shareholder loan agreement to model the consequences (unpaid part added to principal, etc.)

 

12. Calculate the cash available after shareholder loan service

13. Depending on the country legislation, either the full amount remaining can be paid to shareholders or some restrictions may apply (the minimum between the cash available and retained earnings)

Financial Modeling Academy

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