What is a Cash Sweep?

What is a Cash Sweep?

A cash sweep is the use of a company’s excess cash to pay outstanding debts ahead of the scheduled payment date instead of giving it to their investors or shareholders.

This process helps a company to minimize risk and liability as well as pay its debt at a faster rate than what is expected or agreed upon. Companies therefore use the cash sweep feature to reduce their outstanding liabilities instead of letting their money sit idle in a cash account.

Cash sweep accounts are also used by individuals who want to keep their money invested on a daily basis. A cash sweep can automatically “sweep” any excess money in their cash account to a mutual fund or other investment that they choose. The vast majority of banks, investment companies, mutual fund companies and other financial institutions offer this service as a courtesy free of charge.

The amount of cash that is “swept” using this feature is the balance that remains after all other business or personal financial obligations have been satisfied. For a corporation, this means the amount of money that is left after all regular debt payments and operational expenses have been taken care of.

For individuals, this usually means the amount of money that is left after all personal expenses and regular bill payments have been made. In many cases, a cash sweep fund is a money market mutual fund or slush fund. For banks, it can be either a checking or savings account for either an individual or a business.

Some banks offer an overnight Treasury sweep, where excess cash in the sweep account is “swept” into government bond holdings to earn interest all night and then is transferred back to the cash account at the beginning of the next business day.

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How It Works

A cash sweep works by utilizing a borrower’s excess cash to pay down existing debt. To conduct a cash sweep, excess cash is swept up from a borrower’s account and applied towards any existing debt a borrower may have. Cash sweep accounts are used by companies as part of their cash management processes and by individuals to maximize their investment earnings. In both cases, cash sweeps involve excess cash that accumulates after necessary expenses have been accounted for.

For a corporation, excess cash refers to any remaining cash after operating expenses, and regular debt has been paid. Cash sweeps involve agreements between a borrower and their bank to sweep excess cash from their accounts periodically. Typically, cash sweeps occur at the end of each business day, and the excess cash is moved into a separate account and used to pay off existing debt.

For example, if a company has debt remaining from a line of credit, the daily cash sweep would automatically be converted into a debt payment. For individuals, cash sweep accounts can also help maximize investment earnings by transferring excess cash into interest-producing accounts or investment funds.

Cash Sweep Modeling

In Excel, the formula for the cash sweep must calculate the free cash flow once all required payments are met, including the mandatory amortization of debt.

The excess cash is the amount remaining once all of the following have been accounted for:

  • “Rolled-Over” Excess Cash on the B/S from the Prior Period
  • Cash Flow from Operations in the Current Period
  • Cash Flow from Investing in the Current Period
  • Cash Flow from Financing in the Current Period
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If the borrower has remaining excess cash, the borrower can periodically pay down debt early – assuming the credit agreement does not contain language prohibiting such prepayments.

Additionally, the minimum cash balance of the company (i.e. the amount of cash required to be on hand by the company to fund working capital needs) must also be taken into consideration.

Cash Sweep Provisions

In some cases, a cash sweep may be required as part of a borrower’s loan agreement with a lender. To ensure loan repayment, a lender may insert a cash sweep provision into the loan agreement to ensure that a percentage of a borrower’s excess cash is used to prepay the loan.

Cash sweep provisions are more likely to occur with borrowers that operate in volatile industries such as energy or commodities. In such a case, a lender would require the borrower to use a percentage of their excess cash to pay down the existing loan.

By reducing the outstanding loan balance, the cash sweep payments act as a buffer against other years where the borrower may incur lower revenues as a result of industry volatility. Cash sweep provisions can also be found in instances where a borrower wants to extend the length of the loan.

By inserting a cash sweep provision, a lender may agree to increase the term of the loan because the cash sweep provisions reduce the outstanding balance through prepayments, which naturally shortens the length of the loan.

Cash Sweep Accounts

Cash sweep accounts provide a way for individuals to maximize their investment earnings by transferring excess cash into an interest-earning account or an investment fund. In a cash sweep account, excess cash is swept up, moved into a separate investment account, or invested into various investment funds. However, a cash sweep account only invests the money for short periods to ensure that excess cash does not sit idle in a borrower’s account.

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Cash sweeps are typically conducted daily, and at the end of the month, the individual receives an interest or dividend payment. Although the excess cash is moved out of the borrower’s account and into another investment, it is still readily accessible for the borrower should they choose to move into longer-term investments.

Therefore, cash sweep accounts should not be viewed as a long-term investment solution, but rather a means of earning short-term interest by investing excess cash that would otherwise be sitting idle in a borrower’s account.