Revolving Credit Facility

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[Link].73] IAN SCHNOOR: We have now built up the cash section and the long-term debt
section within the debt schedule. That means the only piece left to build on the debt schedule is
the revolver, but the revolver is complex. There's a lot going on and there's a lot to talk about. So
in this lesson, I want to review a bunch of the ideas in the concepts that we need to include in the
revolver. And then in our next lesson, we'll get back to the model, and we'll go ahead and we'll
build it up together.

[Link].99] So I'm going to go ahead and share my screen, so you can see the notes file. Let's
take a look and talk about a bunch of the ideas that we need to include. So we're talking about
here modeling the revolver, the revolving credit facility. What is it? Well, really it's just a piece
of short-term debt that's used to fund cash shortfalls. That's essentially the idea of it. It's like a
credit card. It's also known as-- it's got a bunch of names though. And people refer to this in
different ways, but it's all the same.

[Link].97] You might refer to this or it might be known as a bank line or an operating line or
a line of credit or credit facility or, like I just said, you could think of it almost like a credit card.
It's a way for the company to access credit and liquidity when they are having a bad year. When
they're short on cash, they need to be able to find it somewhere. And most companies will have a
facility like this for situations when they need some cash. What's unique about a revolver though
within a model is as follows.

[Link].81] Most pieces of debt only ever go down. Think about that. If you have some long-
term debt, you borrow it and it goes down. Even personally, if you have a mortgage, it goes
down. It doesn't go back up. It just goes down. And most long-term debt in a company, most
debt in a company for that matter, you borrow it and it goes down, but the revolver is unique. A
revolver in any company is unique because it can go up or down. Some years it goes up, and
other years it will go down.

[Link].99] And so then, the point is therefore that every model you ever build, every single
model you ever build in your life, should have a revolver, even if the company doesn't actually
have one. So I told you, a lot of companies do have-- a lot of companies do have a bank line or a
credit facility. Some don't or it's not being used, but even if you're modeling a company that does
not have a revolver, you must build it into the model anyway, even if they don't have one today.

[Link].19] Again, it sounds like a strange thing to say. You would never build in a piece of
long-term debt if the company doesn't have it. If a company does not have a term loan A, you're
not going to build a term loan A. If they don't have bonds, you're not going to build the bonds.
We generally only build things that the company has. But we need to build a revolver in every
single model, even if the company doesn't have one. Why? Because they might need one. They
might need one in the future if you forecast a bad year.
[Link].39] Remember, you're forecasting into the future. You're forecasting a number of years
into the future. So if you believe that in a future period, they might have a need for cash, if they
might be short, you have to have a facility in your model ready to go that allows them to borrow
when they have a bad year. And if you don't-- if you do not include a revolver in a financial
model and you end up forecasting a bad year, then one of a couple of things happens.

[Link].58] You either end up showing negative cash on the balance sheet. In the asset side,
you end up seeing negative cash, which would never happen. Companies don't ever report
negative cash in the cash line on their balance sheet. They might show zero cash, and then they
would have a piece of short term debt. So in a model, you would either end up with negative
cash or, in some people's models, they just end up with a balance sheet that doesn't balance.
Their balance sheet doesn't balance because they didn't properly reflect what's going on.

[Link].15] So we need to make sure that we capture all of these issues. A revolver is a piece
of liquidity in the event of a bad year. So now, what I want to talk about is this. Because it is so
important, you need to know how to build this in any model you ever build. There are two steps.
There's actually two steps to building up the revolver in a model. Step number one is to calculate
every year how much excess cash or what the shortfall is that the company is expected to
generate during the year, each year.

[Link].06] So is the company expected to have a shortfall? If they're going to be short, then
that's how much they're going to need to borrow. And are they going to excess? If they have
excess, then we might be able to pay it back. But the point is, the step one in doing what the
revolver, in building a revolver, is to understand what's the cash flow every year before the
revolver has to kick in, how much cash happens just before the revolver needs to kind of take
action.

[Link].35] And then the second step in the revolver is to actually build up a revolver section,
just like we've been doing for every other piece of debt. We're going to build the revolver with a
beginning change, ending balance, and then the interest expense, just like we've done for all the
other pieces of debt. Now, what you should know as well is that in many revolvers, if the
company has any excess cash flow during the year, I told you step one is to calculate whether
they have a shortfall or excess cash flow.

[Link].14] For many revolvers, if the company has excess cash flow during the year, they will
have to pay off the revolver or part of the revolver. This is called a cash flow sweep or a cash
sweep, and that's often a feature of revolver. So you need to know that when you are doing
your-- when you're doing your planning. When you're asking questions and planning out the
revolver, you need to know. Is there a cash sweep? Meaning if they have a good year, do they
have to pay back whatever is outstanding on the revolver?

[Link].51] You need to know that and then we can build it. Now that we've talked about the
two steps to build up the revolver, let's get into a critical part of the discussion, which is the fact
that there are four rules. Now that why we build a revolver and you know the steps, what I want
to share with you are the four rules. Every single revolver that you will ever build needs to
satisfy these four rules. So what are they?
[Link].59] Well, rule number one says, if the company has a cash flow shortfall in any given
year, if they have a cash flow shortfall, then you need to borrow or draw. We would say draw
down the revolver, that means to borrow. So rule one, if there's a shortfall, you need to borrow.
The company needs to borrow on its revolver. That's rule one. But then there's a rule two. Rule
two says, well, wait a second. However, if there's a shortfall and you were going to borrow, not
so fast.

[Link].59] It says, first check to see if the company has any excess cash in its bank account
because maybe the company is sitting on a lot of cash in its bank account. It might just be sitting
on cash as excess cash. So if they have a lot of excess cash, they would use that up before they
borrow. So one more time, check and see what the cash flow position is. If they have a shortfall,
if they have negative cash flow, then borrow. But first check to see if they have any excess cash
in the bank because they would use that up first.

[Link].70] Rule three says, if the company has any excess cash flow in a given year, then
repay the revolver. Sweep it. There might be a cash flow sweep. In which case, you would have
to sweep it back to the revolver. And rule four says, yeah, but hang on a second. However, never
repay more than what's outstanding. So if the company has a really good year and they have a lot
of excess cash flow, yes, pay off the revolver, but don't pay off more than what you owe.

[Link].48] Only pay off as much as what is owed, and then the rest of it would just sit as
excess cash in the bank account. That should sound obvious, but people make mistakes with this
all the time. These are the four rules. Now, you remember, we talked about the fact that a piece
of debt has a beginning, change, ending, right? There's always beginning, change, ending. These
rules will all be built into the middle row, the change row.

[Link].61] And as you can probably imagine, because a bunch of them start with if
statements, the way with the word if-- I've said if, if. What a lot of people do is the way they
build this into the revolver. I'm going to put a note that says, how do you actually build this?
Well, the way a lot of people build these four rules into a revolver, in their model, is with a
bunch of if statements. People will build these rules using a bunch of nested if statements.

[Link].85] It gets long, it gets clunky, gets hard to understand, often it's filled with mistakes,
so we don't want to do that. What we're going to do is use a min function. We want to use a min
function. And if you're thinking this, you're right. Technically, this is another constraint. I've
talked a couple of times now in this module about constraints, and there are a few constraints
we've already looked at in financial models. This is effectively another constraint.

[Link].71] And so we're going to build it with a min function, a very simple min function, not
with if statements. So what is it? Well, I'm going to prove this and actually go through it with
you very carefully in our next lesson. But the formula we're going to use is negative, it's going to
have to be a negative min, and it's going to be two things. It's going to be the cash flow plus the
opening cash balance, so that's the first. Cash flow plus the opening cash balance, that's
effectively-- you could refer to this part as the cash available.
[Link].47] How much cash is available during any given year? It's the cash flow that you
generated combined with the amount of cash you started with. That's the cash that's available.
And we're going to compare that with the opening amount of the revolver, the beginning
revolver balance. That might not make perfect sense right now, but I promise you we'll have the
next lesson, I'm going to prove it up. All I want you to see, though, is that all of these four rules
are going to be packaged up in this one very clean, small, elegant formula, a negative min, and
that's it.

[Link].61] So that summarizes the ideas I wanted you to see in this lesson, what we're trying
to achieve with the revolver, why it's so important to have one. I wanted you to see the two steps
that we're going to need in our model to build it, and then the four rules. And then last, here is
the answer. This is the formula we're going to build together. Now that we've gone through all of
that, it's time to build it up. So in our next lesson, we're going to review and build up the revolver
together.

[Link].54] Step by step so you know exactly how to do it and you have it built up properly in
your model. I'll see you then.

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