As we covered in Step 6, if the borrower has excess cash and the terms of the debt provide for early repayment at the borrower’s option, the borrower may use excess cash to periodically repay debt ahead of schedule. This is called “cash sweep.” We calculate excess cash as total cash less any minimum cash balance required for operation of the business. The minimum cash balance is a guess, absent further diligence. Then, we compute the total cash available for debt service/repayment as:
- the excess cash at the beginning of the period, plus
- cash flow from operating activities in the period, plus
- cash flow from investing activities in the period, plus
- cash flow from financing activity related to preferred stock in the period.
From this total cash flow available for debt service we subtract scheduled debt repayment. If this difference is positive, we have more than enough cash to service the debt and can use the excess to pay down the revolver balance or optionally repay other debt early. If the difference is negative, meaning that we have insufficient cash to service the debt, we must draw down (i.e. borrow from) the revolver.
Note that, as we have set up our formulas for optional debt repayment, senior debt would be repaid before junior debt. You may instead wish to repay more junior, higher cost debt first. Which you choose repay first is a judgment call.