Sweep definition free#
In reality, the free cash flow (FCF) amount – i.e. The first step is to list out the model assumptions for our simple cash sweep exercise.įor purposes of simplicity, the “Excess Cash Available for Cash Sweep” line item is assumed to be $40m in all periods. We’ll now move to a modeling exercise, which you can access by filling out the form below. the risk of finding another borrower), which offsets the interest expense savings of the borrower, As a result, bonds and riskier debt securities lower in the capital structure are costlier forms of debt financing.Ī borrower must weigh the pros/cons of using excess cash to pay down debt early, as the benefits of lower interest expense and reduced credit risk must outweigh any prepayment penalties incurred. Lenders set different minimum return hurdles based on their risk tolerance among other various factors, so their willingness to allow for cash sweeps and the associated fee structures tends to be very specific to each particular situation.īy charging a prepayment penalty, the lender is protecting the yield on their debt and receiving compensation for reinvestment risk (i.e. the tax savings caused by interest expense lowering taxable income). One drawback, however, is that the reduced interest expense means the “ tax shield” benefit of debt financing is also reduced (i.e. contributing to a lower debt-to-equity (D/E) ratio.Įarly payment improves the company’s financial stability as well as its ability to secure debt financing on a later date when cash is running low (or refinancing in a lower-interest-rate environment). One of the key incentives for a company to opt for a cash sweep, other than lowering its interest expense burden, is to positively impact its credit profile – i.e. the amount of cash required to be on hand by the company to fund working capital needs) must also be taken into consideration. If the borrower has remaining excess cash, the borrower can periodically pay down debt early – assuming the credit agreement does not contain language prohibiting such prepayments.Īdditionally, the minimum cash balance of the company (i.e. Cash Flow from Financing in the Current Period.Cash Flow from Investing in the Current Period.Cash Flow from Operations in the Current Period.“Rolled-Over” Excess Cash on the B/S from the Prior Period.The excess cash is the amount remaining once all of the following have been accounted for: In Excel, the formula for the cash sweep must calculate the free cash flow once all required payments are met, including the mandatory amortization of debt. Such lenders may also charge substantial prepayment penalties even should early prepayment be allowed. In contrast, other returns-oriented lenders will typically issue debt with provisions prohibiting early prepayment either for a specified period or for the entire duration of the loan. corporate banks), who prioritize capital preservation above all else, will gladly accept early payment with either minimal (or no) early prepayment penalties imposed on the borrower. the periodic payments to the lender in exchange for the borrowing) to decline.Ĭertain debt providers such as senior lenders (e.g. The reduction in debt principal also causes the interest expense (i.e. The discretionary, early pay-down of debt reduces the principal balance coming due on the date of maturity – which decreases the credit risk of the borrower.