The Cash Flow Waterfall: The Order Money Is Paid Out

A waterfall is a written queue. Money arriving from a pool over one period is paid down that queue a step at a time, and each step has to be completed before anything reaches the step under it. Absorption of losses runs on a separate list altogether. When the money runs out, everything below that point is written down at nothing.

Why does money arriving from a pool need an order written for it at all?

Picture the plainest version of the problem. A structure has bought a set of receivables. Over a period, borrowers pay what they owe, and a quantity of money lands in one account. Several parties have a claim on that money. Somebody has to be paid first.

If nobody writes the order down before the money arrives, somebody decides it on the day, and whoever decides gets to choose who suffers. A written order exists for exactly that reason. The order is written into the transaction documentsThe signed papers that bring a structure into existence and set out who is paid what, and in what sequence. An actual queue is read out of these, never out of a summary. before a rupee has been collected. A short period is then settled by a document written months earlier rather than by a judgement made under pressure.

The pieces at Sarvani Receivables Trust and the order in which a pool shortfall is absorbed are both settled already. The second order is not yet in hand, and it is a genuinely separate thing. Sizes say how much of the structure each holder put in. The loss order says who is reached first when receivables go bad. Neither one says what happens to the ordinary money that arrives in an ordinary period. The ordinary money is a third question, with its own answer written somewhere else in the same set of papers.

Here is the sentence to hold on to before the arithmetic starts. The order is the protection, not the total. A holder standing high in the queue is not protected because a large amount of money arrived. A holder high in the queue is protected because the document says their step is completed before the next one begins, and that promise does its work most on exactly the periods when the money is thin.

What does the queue at Sarvani Receivables Trust actually say?

Sarvani Receivables Trust, a structure built for teaching, holds a pool of Rs 1,200 crore of receivables. Three pieces fund it, and their sizes are set out in the table so the arithmetic has somewhere to stand.

Absorption climbs. The path begins at the equity piece. The mezzanine piece lies next along its path. The senior piece is the last thing it can reach, and the two pieces underneath add to Rs 240 crore. Set against a pool of Rs 1,200 crore, Rs 240 crore reads as a fifth, or 20.0 per cent. The absorption order is covered separately; what follows contrasts against it.

Now the second order. Over one period, Sarvani Receivables Trust pays what it has collected down five steps, and those five scheduled amounts add to Rs 106 crore. The figure sets out what each step is due. Read the figure. The sentence under it, about where the queue came from, matters more than the amounts do.

The source of these amounts matters. The five amounts are declared, not collected. The pool, the three sizes and the direction absorption runs in are fixed quantities. No record exists of what a structure collected in any period, or of what it had scheduled against that period. So the five amounts above are a declaration, the two collections worked below are declarations, and every position on the control further down is a declaration too. Declarations of this kind are chosen to make an order visible. A declaration is not evidence about anything.

The first step is not a piece. Nobody bought it, nobody put money in against it, and it carries no place at all in the loss order. The first step is what the servicer and the trustee are owed for doing the period's work, and it stands ahead of every holder in the structure. Why that position makes sense comes below; for now, the cash queue contains an entry that the loss order has no name for.

What is the one rule that turns a list into a waterfall?

A list of five claims is not yet a waterfall. A rule about completion makes it one: a step is paid in full before the step beneath it receives anything at all. No proportional sharing at any point. No settling everybody partly. No discretion on the day.

The word is doing real work. Water poured into a stack of bowls does not distribute itself fairly. The top bowl fills completely, and only then does anything spill into the second. With a small amount poured in, the top bowl is brim full while the bottom one is bone dry. The result looks unfair until one remembers that everybody agreed the arrangement before the pouring started, and the bottom bowl was cheaper to stand in for exactly that reason.

Two consequences fall straight out of the completion rule. The first is that a shortage never spreads. A shortage concentrates. The whole of it lands on whichever step the money stopped at and on everything below. The second is that the exact place where a period ran out can always be named. A waterfall converts a vague statement about there not being enough money into a precise statement about one position in a list.

Why does a step that belongs to nobody stand ahead of every piece?

The first step is Rs 10 crore of costs, and a reader meeting it usually wants to argue with it. Why should the people running the structure be paid before the people who funded it? The arrangement looks like the wrong priority written down as a rule.

The priority is right, and the reason is worth stating plainly. Somebody has to collect from every obligorThe borrower on the other end of one receivable in the pool, whose payments the structure is waiting for. Who was lent to, and on what terms, is settled in the lending material rather than here. in the pool, chase what has not arrived, keep the records, hold the money apart from everybody else's and hand it out on the right day. If that work stops, there is no collection at all in the next period, and a queue with nothing flowing down it protects nobody. The costs of running the structure sit at the top because every step below them depends on the work they pay for.

A building with a lift makes the point. The residents on the top floor have paid the most and would be first in most queues. The lift is what makes the top floor reachable at all, so the electricity bill for it gets paid before any of them are served. The bill is small. The bill is also the only item whose non-payment stops everything else.

There is a second reason, and it is about incentives rather than mechanics. Placing the running costs at the top means the servicer and the trustee are paid the same amount whether the period was good or thin. The servicer and the trustee therefore have no interest in the outcome for any particular holder, and indifference is exactly what is wanted from somebody whose job is to apply a written order rather than to take a view on it. Whether a real structure has to be arranged that way, the servicer’s own list of obligations, and where money already collected goes if that role changes hands, are all set by the Reserve Bank of India at rbi.org.in, where the current wording is maintained.

Are the cash queue and the loss order two readings of one list?

The two orders are not two readings of one list. Careful readers most often go wrong here, and the mistake is a reasonable one. A list of three pieces already carries an order. A second order turns up. The natural move is to assume the new one must be the old one turned round.

The loss order turned round gives: senior piece, then mezzanine piece, then equity piece. Set against the actual queue, the direction is right. The contents are wrong in two separate ways.

The first difference is the one already noted: the cash queue begins with an entry that is not a piece. The loss order has three names in it and cannot accommodate a fourth party who absorbs nothing and is paid first.

The second difference is sharper, and it is the fact a three-name diagram is incapable of holding: the senior piece stands in the cash queue twice, at the second step and again at the fourth. Rs 44 crore reaches it at the second step as the amount due. Rs 28 crore reaches it at the fourth as principal returned, and that repayment reduces the amount still owed. Add those and Rs 72 crore of the Rs 106 crore scheduled for the period is going to one piece across two separate positions.

Why would a document ever pay one piece at two separate places? Because the two payments are different kinds of thing. One is what is due for the period. The other is a return of what was originally put in, and it shrinks the amount still owed. A holder receiving both wants them recorded separately, and a document that merges them into a single line has thrown away the distinction between being paid for waiting and being repaid.

The general lesson sits here. A queue for money and an order for losses are separate documents about separate events, so neither can be reconstructed from the other, and the number of entries in one need not match the number in the other. A reader who works out the cash queue by reversing the loss order gets the direction right and the contents wrong. A near miss of that kind is the most expensive sort: it survives a sanity check.

Where exactly does a short collection stop?

Now the arithmetic, and it is arithmetic that fits on the back of a receipt. A collection of Rs 100 crore is declared for the period, against Rs 106 crore scheduled. The period is Rs 6 crore short, and the whole question is what that Rs 6 crore does.

Work down. Rs 10 crore of costs leaves Rs 90 crore. Rs 44 crore to the senior piece leaves Rs 46 crore. Rs 18 crore to the mezzanine piece leaves Rs 28 crore. The fourth step wants Rs 28 crore of principal for the senior piece and there is exactly Rs 28 crore there, so it is completed and nothing at all remains. The fifth step is reached with an empty account, and the equity piece is written down at Rs 0/- for the period.

Read the last two bars carefully. The lesson sits in them. The queue did not thin out gradually. The money ran at full strength through four steps and then stopped dead. A shortage of Rs 6 crore in a Rs 106 crore period did not cost five parties a little each; it cost one party everything it was scheduled to receive and cost the other four nothing whatsoever.

A coincidence sits in the middle of that walk. After the third step, the balance left reads Rs 28 crore, and Rs 28 crore is also what the fourth step is scheduled to receive. The balance and the schedule are two different quantities that happen to print the same digits. One is a running balance and one is a promise. The collision is not a defect in the example. A running balance is built by subtracting the scheduled amounts, so it passes through them as a matter of arithmetic. The collision is the reason every figure above says whether it is scheduled, paid or left.

At what collection does each step fill?

The walk above answers one collection. The amount needed to complete any step is simply the sum of that step and everything above it, so pushing a little further makes the queue answer all of them at once.

Adding along the queue gives five landmarks. The first step is complete once Rs 10 crore has arrived. The second is complete at Rs 54 crore. The third at Rs 72 crore. The fourth at Rs 100 crore. The worked run above therefore landed exactly on a boundary. The fifth and last is complete at Rs 106 crore, and every rupee beyond that is over.

Something quietly elegant falls out of those five numbers. The stretch of collection over which any step is only partly filled is exactly as wide as that step is scheduled to receive. The second step is partly filled anywhere between Rs 10 crore and Rs 54 crore, a stretch of Rs 44 crore, and Rs 44 crore is what the second step is scheduled to get. The last step is partly filled only between Rs 100 crore and Rs 106 crore, a stretch of Rs 6 crore wide. The match holds for every step in every queue of this kind, and it can be checked above on five rows.

The last band is worth staring at. The band runs from Rs 100 crore to Rs 106 crore and is Rs 6 crore wide, the narrowest window in the queue by a distance. The calculator below moves in Rs 10 crore steps, so it skips straight over that band and never once shows the equity piece being partly paid. The miss is not a gap in the control. The arithmetic of the queue is showing through: the last step is the smallest, so the window in which it is partly filled is the narrowest, and a coarse instrument will always miss the narrowest window first.

What does the same queue do with a longer collection?

Change one thing and nothing else. The five scheduled amounts stay where they are. The order stays where it is. The pool is the same pool. Only the collection moves, and this time it is declared at Rs 130 crore.

Rs 10 crore of costs leaves Rs 120 crore. Rs 44 crore to the senior piece leaves Rs 76 crore. Rs 18 crore to the mezzanine piece leaves Rs 58 crore. Rs 28 crore of principal to the senior piece leaves Rs 30 crore. The equity piece takes its Rs 6 crore, and Rs 24 crore is still sitting there. Now the interesting part: every scheduled step has been completed and there is still money in the account.

The Rs 24 crore left standing is the residual: it is what a period leaves once every scheduled step has been completed, and by declaration it goes to the equity piece. Notice how it was produced. Nobody promised it. Nobody calculated it in advance. The residual is a leftover, arrived at by subtraction, and it exists only because the collection happened to exceed what the period had scheduled.

The sequence has been walking towards this spot. Credit enhancement, covered separately, names excess spreadThe cushion that exists when a pool brings in more over a period than the structure has promised to pay out of it. It is treated as a form of protection under credit enhancement; what appears here is only the place in the queue where such a surplus would surface. as a form of protection without working it through. Where a surplus shows itself is here: the bottom of the queue, after every scheduled step. And the limit has to be stated in the same breath. One declared period is not a spread. A spread is a pattern across many periods, and one declared period cannot show a pattern. The Rs 24 crore illustrates where a surplus lands; it is never evidence that one does.

What is the equity piece, once both runs are read together?

Put the two runs side by side and the character of the last piece in the queue writes itself. On the Rs 100 crore collection the equity piece received Rs 0/-. On the Rs 130 crore collection it took its scheduled Rs 6 crore, then the residual behind that, for Rs 30 crore over the period.

Now cross that with the other order. In the loss order the equity piece is reached first. In the cash queue it stands last. The same piece is at the front of one queue and at the back of the other. The whole of its character sits in that one fact: it feels a shortage in the pool before anybody else and it feels a surplus after everybody else.

Which of those two runs is the ordinary one cannot be settled here. Deciding that would need a record of what pools of this kind collect period after period, and no such record sits behind these notes. Both runs are drawn, both are labelled as declared, and which of them turns up more often stays open.

Is receiving nothing the same as absorbing a loss?

The distinction between the two is the one a reader is most likely to walk past.

On the Rs 100 crore collection the equity piece received Rs 0/-. Read that sentence and check what it actually says. The sentence says the period arrived Rs 6 crore short of what the queue had scheduled, and the money stopped before the last step. The sentence does not say that a single receivable in the pool was written offGiven up on in a structure’s own records, so the amount stops being counted as money still expected. It is a decision recorded about a receivable rather than a shortage of cash in one period.. Nothing at all ran up the loss order. The pool is exactly as large as it was.

Being paid nothing in a period is a cash event; absorbing a loss is a pool event; and the two arrive by different mechanisms even though they can look identical from where the holder sits. A holder who checks the account on the distribution day sees the same thing in both cases. The distinction therefore has to be made in the document rather than in the bank statement.

The fate of that Rs 6 crore is a genuinely open question. The shortfall might be caught up out of a later collection. The shortfall might simply never arrive. Only the documents of an actual structure settle which of the two happens, and a single declared period holds no second period to settle it against. Separately, the line at which a note is called defaulted for reporting, and whose call that is, belongs to the Securities and Exchange Board of India (SEBI) at sebi.gov.in. The Board revises that line, and no copy of it is written out above.

A receivable that has fallen into arrearsPayments that were due on a date and have not turned up. A receivable in arrears has fallen behind its dates; it has not necessarily stopped for good. is a third thing again, sitting between the two. A receivable in arrears has not been given up on, and it is not paying. The treatment that applies to it is set by the Reserve Bank of India at rbi.org.in.

The same rule, running in a household on the first of the month

A salary of Rs 60,000/- lands on the first. Taped inside a cupboard door there is a list nobody in the house argues about: rent Rs 22,000/-, the school fee Rs 12,000/-, the loan instalment Rs 15,000/-, the month’s groceries Rs 9,000/-, and whatever survives all four goes into a box on the shelf. The four written items add to Rs 58,000/-, so in an ordinary month Rs 2,000/- reaches the box.

Now a month arrives where only Rs 50,000/- comes in. Nobody in that house pays five sixths of the rent and five sixths of the school fee. The rent is paid in full. The fee is paid in full. The instalment is paid in full. Rs 1,000/- is left when the groceries are reached, Rs 8,000/- less than the list asked for, and the box on the shelf gets nothing at all.

Nobody in that house thinks the box is being punished. The box is standing last, and standing last is what makes it the place where a thin month is felt. The equity piece stands in exactly the same position, and it is not being penalised for anything either. The equity piece agreed to stand at the end of the list, and the end of the list is where a short period lands.

How does somebody actually read this queue on a working day?

Somebody thinking about standing in the mezzanine position does not start by asking what the position might be worth. Such a holder starts by asking what is in front and what is behind. A queue answers that directly and answers almost nothing else directly.

In front of the mezzanine step sit two entries: Rs 10 crore of costs and Rs 44 crore due to the senior piece, adding to Rs 54 crore. So a collection has to reach Rs 54 crore before the mezzanine step sees a single rupee, and it has to reach Rs 72 crore before that step is completed. Behind it sit Rs 28 crore of senior principal and Rs 6 crore due to the equity piece, adding to Rs 34 crore. The Rs 34 crore is the cushion of scheduled payments standing between this holder and the very bottom of the queue.

The three figures are what the queue gives up, and they are all it gives up. The reading names a position in a list and what has to arrive before that step is reached. The queue does not say whether Rs 72 crore usually arrives. The queue cannot say how often a period falls short, or by how much when it does, and it certainly does not say whether standing there is a sensible thing to do. A person who reads Rs 54 crore and concludes that the position is safe has read the arithmetic correctly and then added a claim the arithmetic does not contain.

The same reading works from the other side. A servicer preparing for a distribution dateThe day in a period on which a structure hands money out to those standing in its queue, as against the days on which it is collecting money in. does not decide anything; they apply the list. The trustee’s job is to check that the list was applied as written rather than as convenient. And a holder wanting to know what was actually done in a period is relying on a disclosureSomething a structure is required to tell the people holding its notes. What must be told, and how often, is decided by an authority rather than by whoever built the structure. rather than on arithmetic. The collection is a fact about the world, and nobody can derive it.

What can one period not settle?

What the queue delivers is a smaller thing than it feels like, and knowing its edges is most of the value.

The order is in hand, and exactly where a collection of any size stops in it can be stated. That is a real capability, and it is the whole of what a written queue delivers. What a queue settles is where the money stops; how often it stops early, and how far short it falls when it does, are questions a queue cannot reach.

Answering those would take a run of periods with a collection recorded against each, and then some honest arithmetic on the run. What sits here is one declared period, worked twice at two declared collections, with six more offered on a control. Six declarations are not a sample of anything. Six illustrations chosen to make an order visible say what the order is, and say nothing about how often a pool behaves one way or another.

So there is no frequency attached to any step of this queue. No holder is told their position is a comfortable one. Sizes and an order are fixed and nothing else: no distribution of losses, no assumption about how the receivables in the pool move together, no schedule of periods. The absence has consequences that can be checked line by line. No step in the queue above carries odds. No grade is attached to the senior, mezzanine or equity position. The word safe attaches to nobody in the list. An empty space where a probability would sit is worth more to a reader than a confident figure with no measurement underneath it.