Modelling test: Vastrakala Garments has a Rs 250 crore term loan with a 100% cash sweep, a Rs 100 crore PIK note at 14%, a Rs 50 crore revolver and a Rs 10 crore cash floor. Fill in the three-year debt schedule.

The term loan falls from Rs 250 crore to Rs 141.65 crore, the PIK note grows to Rs 148.15 crore, the revolver is never drawn and cash sits at Rs 10 crore throughout. Cash before interest is 50, 58 and 66.8; term loan interest on the opening balance is 25, 22.5 and 18.95; the sweep is 25, 35.5 and 47.85. Total debt falls only from Rs 350 crore to Rs 290 crore, because the PIK adds back Rs 48 crore of what the sweep repays.

Cash first, then the instruments in the order the documents rank them. Start with cash before interest, pay cash interest, hold back the floor, repay any revolver balance, and only then sweep what is left into the term loan; the PIK note accrues on its own line and takes no cash at all. A household does the same at month end: pay the card interest, keep an emergency balance, clear the overdraft, then prepay the home loan with whatever is left. The cash sweepA loan term that requires surplus cash above an agreed minimum to be used to repay the loan early, rather than kept or distributed. is the prepayment; the PIK notePayment-in-kind debt: interest is added to the principal each period instead of being paid in cash, so the balance compounds. is the relative who agreed to be paid at the end, with interest on interest.

Year 1: EBITDA 80 less 30 of capex, tax and working capital leaves 50. Term loan interest is 10% of 250, 25. Cash already sits at the Rs 10 crore floor, so 25 sweeps and the loan closes at 225. The PIK accrues 14 and closes at 114. Year 2: cash is 58, interest 22.5 on the lower balance, sweep 35.5, loan 189.5; PIK accrues 15.96 to 129.96. Year 3: cash 66.8, interest 18.95, sweep 47.85, loan 141.65; PIK closes at 148.15. The revolver never moves because cash never threatens the floor.

Only when cash would otherwise fall below the floor, and the test is checking that you built it that way rather than drawing it by hand. If year 1 EBITDA were Rs 50 crore instead of 80, cash before interest would be 20 against 25 of interest, cash would fall to 5, and the revolver would draw exactly 5 to restore the floor; nothing would sweep. In that downside, year 2's surplus of 4.55 repays most of the revolver before any term loan repayment, and the term loan only starts to shrink in year 3. Build the draw as the shortfall below the floor, capped at the Rs 50 crore limit, and the repayment as the first use of any surplus.

That the headline deleveraging is flattered by the PIK. The term loan falls by Rs 108 crore in three years, but the PIK note grows by Rs 48 crore, so total debt only falls from Rs 350 crore to Rs 290 crore and leverage from 4.4x to 3.0x. The sponsor is paying 14% compounding for the privilege of sending every rupee to the 10% loan, which makes sense only if the term loan's covenants are the binding constraint. Say the checks you would run next: the interest circularity if interest were on average balances, the tax shield on PIK interest, which the flat Rs 10 crore of tax ignores, and whether the sweep is really 100% or steps down as leverage falls.