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Cash Waterfall and Integrated Cash Waterflow Modeling

Cash Waterfall and cash flow modeling, one of the different types of financial models, is a mechanism that helps in determining the allocation of the monthly interest and the principal cash flows among the parties involved in a transaction. It’s a method of payment in a collateralized debt obligation (CDO) structure. It suggests that both the interest and principal payments are all paid in proper sequence employing the cash flows that are generated from the collaterals. The highest-ranking tranches (interest and principal payments), also known as senior tranche, are paid first, followed with the lower ones (junior tranche) with equity tranche being the last paid.

A company can have both senior and junior debt, equity, and other financial instruments wherein each of the tools entitles the owner to individual rights and the payment priority. The cash flow modeling ensures that each stakeholder of the company receives the cash based on a pre-agreed order as follows:

The order of distribution:

  • Operation Cost The foremost in the list is paying the operation cost first to keep the company running.
  • Capital Expenditures A company might decide on reducing capital expenditures; however, they must pay the suppliers before any stakeholder.
  • Debt Service Creditors hold the priorities over the cash flow generated by a company even before the stakeholders. The tranches of debt can contain various levels of seniority. The more seniority, the more would be the priority.
  • Corporate Tax If the company is making a profit, paying tax is compulsory. However, it is junior to debt as the company can negotiate a delay with the tax administrator, in case there is a short of cash flow.
  • Preferred Equity and Common Equity While the preferred equity is senior to common equity, the later must be given priority when all the previous stakeholders have been paid.
Cash Waterfall

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The main objective of the cash flow model of an organization is that the cash flow items follow the correct order of distribution based on seniority.

In a finance project, the summary of the cash flow is dome using the cash flow waterfall method showing the priority or the seniority of the cash inflow and outflow. The mechanism is utterly essential when prioritizing the debt repayments of many debt tranches.

Important Points to Consider in Cash Flow Waterfall Modeling

The specifications in the term sheet hint the seniority of the reserve accounts. The annual cash flow waterfall model enhances the efficiency of the model since it helps in in-depth analysis. It ensures that the debt is paid for maintaining the tranche seniority. It has high importance in the scenario analysis or downside sensitivity were operating with the cash flow is highly nerve-racking. The process is also used to calculate the movement in cash balance and cash closing balance.

The cash flow waterfall mechanism is used in different phases of finance modeling. The major lines of the cash flow waterfall are as below:

  • Cash Flow Available for Debt Service – It covers all debt repayment calculations and ratios, for example – debt service coverage ratio (PLCR), loan life coverage ratio (LLCR), project life coverage ratio (PLCR).
  • Cash flow to check that the initial construction costs are met.
  • Cash flow available for the debt service reserve account (DSRA)
  • Cash flow available for calculating the distribution
  • Net cash flow

The image below explains the cash flow waterfall model clearly. Each category is separated into individual lines and items serving as a particular operating cost. Going down, the seniority of each cash flow and the key cash flow lines are highlighted.

Cash Waterfall project finance Module

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Benefits of Cash Flow Model

Cash flow modeling helps insolvency of a company very effectively enabling the organization to be a sustainable one allowing a better understanding of the effect of the drivers on the cash flow, directing to better decision making. It provides in-depth financial analysis and helps in scenario analysis as well as scenario analysis, leading to a better reporting of cash flow performance in the present and forecasting the future cash flow. It also indicates the cash impact of decisions of investment while enhancing access to the capital of the business. It is also a major part of investment research.

Marks and Spencer adopted the cash flow modeling to deliver £185m cash flow in 2007 and within 2010. It helped them with improved cash management. During this period, by conserving cash, they were able to manage net debt to help the company to maintain its credit rating, sustaining the cost of borrowing and its profits.

Thus, cash flow modeling is among the vital types of financial planning models, aiding, especially in debt management and priority payments. The process distinctly helps a firm to have a clear picture of the seniority or the order of the cash flow distribution. Contact the best financial modeling services provider to outsource and get outsourcing benefits.

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