Balance sheet questions
Have a summer analyst interview and am trying to wrap my head around the following:
1) In a debt financing, why does debt not cause cash to simultaneously increase on the balance sheet? Is this because it would cause the B/S not to balance?
It does cause cash to increase simultaneously until it is spent.
Perhaps there's a misunderstanding, but when you ask why cash doesn't increase, I believe it actually does. When a company takes on debt, both cash (an asset) and liabilities increase, thus maintaining balance. There is no immediate impact on the income statement, but the cash flow statement records an increase in cash flow from financing activities. This increase represents an inflow as cash levels rise, becoming an outflow when the debt is repaid. If your question is related to why there's no net impact, it's because when assets (in this case, cash) increase, liabilities increase correspondingly, effectively cancelling each other out.
Yes, but in an LBO model, wouldn’t cash not increase if you are providing a loan to a company? For example, if I provide a $50 loan to a business, does cash on the assets side go up by $50 and liabilities go up by $50 as well? Would the cash go up as it is reflected on the CF statement as “debt proceeds” and then flows into the period’s change in cash?
The target company in an LBO will not be raising debt. Investors raise debt in a BidCo, which will then together with the equity check buy the target. BidCo will merge into the target and BidCo debt stays on target BS
If you open up a credit line with a bank, lets say you have a credit card. Credit card turns up in the mail, you have zero cash and zero debt. You just have a credit card.
You go down to the ATM and (hypothetically) withdraw cash with this credit card. You now have $500 cash. But you also owe american express $500.
A debt is only a debt when it is DRAWN DOWN
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