Model Test MM
Anyone ever experience a model test with negative levered FCF after mandatory payment? I couldn’t do the revolver adjustment because I didn’t have time, but it certainly feels wrong…
Just want to know if this is a thing
Negative levered free cash flow (FCF) after mandatory debt payments can indeed occur, and it’s not necessarily "wrong." Based on the most helpful WSO content, levered FCF represents the cash flow available to equity holders after accounting for all operating expenses, taxes, capital expenditures, and mandatory debt payments. If mandatory debt payments exceed the cash flow generated, the levered FCF will turn negative.
This situation can arise in scenarios such as: 1. High Debt Obligations: If a company has significant mandatory debt payments, it can push levered FCF into negative territory, even if the company is profitable from an unlevered FCF perspective. 2. Insufficient Operating Cash Flow: A company might generate enough cash flow to cover operating expenses and capex but fall short when mandatory debt payments are factored in. 3. Temporary Cash Flow Issues: Seasonal businesses or companies undergoing a downturn might experience negative levered FCF temporarily.
In such cases, a revolver adjustment or other financing mechanisms (e.g., drawing on credit lines) would typically be used to cover the shortfall. However, if you didn’t have time to model the revolver adjustment, the negative levered FCF might feel incomplete but is still a valid outcome based on the inputs provided.
This scenario also highlights the importance of understanding the implications of negative levered FCF, as it could signal potential risks for equity investors, especially in the event of financial distress or bankruptcy.
Sources: Levered vs. Unlevered Free Cash Flow Difference, Walk me through a DCF, FCFF vs Unlevered FCF - is there a difference?, https://www.wallstreetoasis.com/forum/real-estate/megafund-repe-modeling-test?customgpt=1, Corp Dev LBO returns question: Levered and Unlevered IRR
I've done 10-15 LBO model tests + some 3 statements for public equities. Have never had negative CF or a need to pull down revolver.
are three statement models only used for public equities? Is all M&A banking LBO, DCFs
When free cash flow goes negative in a period, the model should draw on the revolver to cover the shortfall instead of letting cash fall below the minimum balance. A clean way to set it up is to calculate cash available for debt repayment as beginning cash plus free cash flow minus the minimum cash balance. If that number is negative, the revolver draw is the lesser of the shortfall and the remaining undrawn capacity, so use a MIN formula against the facility size less the current balance. In periods where cash is positive, repay the revolver first before any optional term loan paydown or cash sweep, since it is usually the cheapest and most flexible facility to pay off. Base revolver interest on the average or beginning balance and add a commitment fee on the undrawn portion. If you calculate interest on average balances, turn on iterative calculation or add a circularity breaker toggle so the model does not blow up. Finally, check that the revolver never exceeds its limit, because a draw that maxes it out is a sign the deal is overlevered.
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