Excess Cash Flow

What Is Excess Cash Flow?

Excess cash flow is a term utilized in loan agreements or bond indentures and alludes to the portion of cash flows of a company that are required to be repaid to a lender. Excess cash flow is regularly cash received or produced by a company as incomes or investments that triggers a payment to the lender as stipulated in their credit agreement.

Since the company has an outstanding loan with at least one creditors, certain cash flows are subject to different reserves or limitations for utilization by the company.

Understanding Excess Cash Flows

Excess cash flows conditions are written into loan agreements or bond arrangements as restrictive covenants to give extra cover to credit risk for lenders or bond investors. Assuming that an event happens that outcomes in excess cash flows as defined in the credit agreement, the company must make a payment to the lender. The payment could be made a percentage of the excess flow, which is generally dependent on what event created the excess cash flow.

Lenders in this way impose limitations on how excess cash can be burnt through in an energy to keep up with control of the company's cash flow. In any case, the lender must likewise be careful that these limitations and limitations are not severe to the point that they obstruct the company's financial standing or ability to develop, which could wind up really hurting the lender.

Lenders define what is viewed as an excess cash flow typically by a formula that comprises of a percentage or amount far in excess of expected net income or profit throughout some time span. In any case, that formula will shift from one lender to another, and it depends on the borrower to arrange these terms with the lender.

Events Triggering Mandatory Payments

Assuming a company raises extra capital through some funding measure, for example, a stock issuance, the company would probably be required to pay the lender the amount created minus any expenses that happened to produce the capital. For instance, on the off chance that a company issues new equity in a secondary offering, the money raised would trigger a payment to the lender. Likewise, if a company-gave debt through a bond offering, the proceeds would probably trigger a payment to the lender.

Asset sales could likewise trigger a payment. A company could have investments or hold shares, for example, a minority interest in different companies. On the off chance that the company sold those investments for a profit, the lender would probably require payment for those funds. Proceeds earned from a side project, acquisition, or windfall income from winning a claim may likewise trigger the clause.

Exemptions for Excess Cash Flow

Certain asset sales may be excluded from triggering a payment like the sale of inventory. A company in its normal course of operation could have to buy and sell inventory to create its operating income. Thus, all things considered, an asset sale, which involves inventory would be exempt from a prepayment obligation.

Other operating expenses or capital expenditures (CAPEX) may be exempt from triggering a payment, for example, cash utilized as deposits to land new business or cash held at a bank that is utilized to assist pay for a financial product that fences with marketing risk for the company.

Computing Excess Cash Flows

There is no set formula for working out excess cash flows since each credit agreement will quite often have fairly various requirements that will bring about a payment to the lender. An estimate of a calculation of excess cash flow could start with taking the company's profit or net income, adding back depreciation and amortization, and deducting capital expenditures that are important to support business operations, and dividends, if any.

At the end of the day, a credit agreement could frame an amount of excess cash flow that triggers a payment, yet in addition how cash is utilized or spent. A lender could permit cash to be utilized for business operations, potentially dividends, and certain capital expenditures. The terms characterizing excess cash flow and any payments are commonly negotiated between the borrower and the lender.

Assuming that excess cash flow is produced, a lender could require a payment that is 100%, 75%, or half of the excess cash flow amount.

Excess Cash versus Free Cash Flows

Free cash flow i(FCF) s the cash a company produces through its operations, less the cost of expenditures on assets. As such, free cash flow is the cash left over after a company pays for its operating expenses and capital expenditures. FCF shows how efficient a company is at generating cash. Investors utilize free cash flow to measure whether a company could have sufficient cash, in the wake of funding operations and capital expenditures, to pay investors through dividends and share buybacks.

The excess cash flow amount for a company is not quite the same as a company's free cash flow figure. Excess cash flow is defined in the credit agreement, which could specify for certain expenditures to be excluded in the calculation of excess cash flow. Exemptions for excess cash flow may be taxes paid, cash used to produce new business, yet these cash outlays would be remembered for the free cash flow calculation.

Theoretical Example of Excess Cash Flow

In 2010, Dunkin' Brands, Inc. gone into a credit agreement with Barclays Bank PLC and a number of different lenders party to the agreement for a US$1.25 billion term B loan and $100 million revolver lines of credit.

Below are the legal terms utilized in the credit agreement characterizing excess cash flow. Under "Defined Terms" of the agreement, excess cash flow is explained in a verbal formula as "an amount equivalent to the excess of":

• (a) the sum, without duplication, of:
• Consolidated net income of the borrower for such period
• An amount equivalent to the amount of all non-cash charges (counting depreciation and amortization)
• The consolidated working capital adjustment for such period

Over:

• (b) the sum, without duplication, of:
• An amount of all non-cash gains, income, and credits remembered for showing up at such Consolidated Net Income
• The [dollar] amount of capital expenditures, capitalized software expenditures, and acquisitions
• Consolidated Scheduled Funded Debt Payments
• The [dollar] amount of Investments made in cash ... made during such period to the degree that such Investments were financed with Internally Generated Cash Flow, plus any Returns of such Investment
• The aggregate consideration to be paid in cash...relating to permitted acquisitions

Every one of the capitalized terms in the above selection are "Defined Terms" in the agreement. The excess of "(a)" things over "(b)" things are carefully spread out as the definition of excess cash flow. The featured things in the above model are in no way, shape or form comprehensive; all things being equal, they represent the fine subtleties of a definition of excess cash flow.

Likewise with any financial measurement, there are limitations to involving excess cash flow as a measure of a company's performance. The amount that is viewed as excess is determined by the lender and doesn't address the true cash flow of the company since things are excluded from its calculation to assist the business with working on its performance to guarantee repayment of the debt.

A Numerical Example

Say that speculative Company A has the accompanying financial outcomes toward the year's end:

• Net income: $1,000,000
• Capital expenditures for operations: $500,000
• Interest paid on debt with cash: $100,000

Assume that both Capex and the interest paid are permitted under the credit agreement meaning the company can involve cash for those expenses. Be that as it may, any cash left over in the wake of deducting the expenses from net income would be viewed as excess and trigger a payment to the lender.

• Excess cash flow: $400,000 or ($1,000,000 - $500,000 - $100,000)
• Percentage of excess cash flow for payment: half
• Payment due to lender: $200,000 or ($400,000 * half)

Features

• Assuming excess cash flow is produced, a lender could require a repayment that is all or some portion of the excess cash flow amount.
• In any case, the lender would rather not make such countless limitations that it harms the financial viability of the company.
• Lenders impose limitations on how excess cash can be burnt through in an energy to keep up with control of the company's debt repayments.
• Excess cash flow is cash received or produced by a company that triggers a repayment to a lender, as stipulated in their bond debenture or credit agreement.