The issuance and repayment of debt is a balancing act that takes into account the cash available to the company. Holding on to too much cash is detrimental to the company because of the opportunity cost while too little cash could result in a company being unable to pay off its debt obligations.
The steps to calculate debt repayments are as follows:
- Determine the free cash flow at the start of the year (everything but financing activities) and add it to the cash balance at the start of the year
- Determine a minimum cash balance that the company would like to have on hand and subtract it. This figure represents the FCF available for financing activities.
- Add/Subtract the cash flows from financing activities apart from debt. By now, these should all have been calculated.
- Sum up the cash flows and that is what is available to repay the debt.
- Determine the effects of net debt (issuance and repayment). Look in the management footnotes to determine when debt is due and when it is required.
- Is the cash available enough to repay the net debt?
- If so, then pay it off. The remainder is what is available to repay short term debt.
- If the number is negative, then you must draw from the short term debt to pay off the long term debt.
- Add back your cash reserves.
Using the management notes, calculate the historical interest rates charged on the debt. This amount may not match up with the interest expense shown in the income statement. This can be caused by the payment and repayment of short term debt or through the use of derivatives to convert floating to fixed or fixed to floating. It’ll be too difficult to reconcile the differences, so add a plug.
Forecast the future interest rates based on debt and make reasonable assumptions for Other interest.
Example: Cisco Debt and Interest
Step 1: Create a new sheet and link the free cash flow and cash balance from the statement of cash flows and balance sheet. Estimate the minimum cash balance that the company should have on hand.
Step 2: Add the cash flows from financing that are unrelated to debt. The sum of the FCF and cash from financing activities is the cash that the company has to service its debt.
Step 3: Add the debt that the company has on its books and forecast it out. Go through previous year’s financial statements to get the figures. FY2010 and FY2009 figures can be found on page 62 of the FY2010 AR. 2008 figures can be found on page 66 of the FY2008 AR. Forecast future debt levels based on each note’s due date.