Unit 8 · Unit 8: Capital Structure
How the model finances itself: a clean debt schedule, a revolver that plugs cash, capital returned to shareholders, and the circular loop that ties them together.
Opening balance, draws, repayments, and interest — rolled forward each period.
Once you have forecast operations — revenue, costs, capex, and working capital — you have to decide how the business is financed. The debt schedule is where that happens. It is a small roll-forward table that tracks each tranche of debt from its opening balance to its closing balance, layering in any new draws, subtracting scheduled repayments, and calculating the interest the company owes along the way.
The discipline is the same as every other schedule in the model: you build the calculation once and let it feed the statements. The closing debt balance lands on the balance sheet, the interest expense lands on the income statement, and the cash movement from draws and repayments lands in the financing section of the cash flow statement. Nothing is typed twice.
Closing debt = Opening debt + Draws − RepaymentsThe closing balance of one period becomes the opening balance of the next — that's the roll-forward.
Interest = Interest rate × Average debt (where Average debt = (Opening + Closing) / 2)Charging interest on the average balance is more accurate than on the opening balance — but, as you'll see, it is exactly what creates circularity.
Average vs. beginning balance Interest on the average balance is the more precise convention, but it references the closing balance you're still computing. Many desks deliberately charge interest on the beginning balance to break the loop — a small accuracy cost for a model that never goes circular.
A revolving facility draws to cover shortfalls and is swept down when cash is plentiful.
A revolving credit facility — the revolver — is the financing line that makes the model self-balancing. Think of it as a corporate overdraft: when the business doesn't generate enough cash to cover its obligations, the revolver draws down to fill the gap; when the business throws off more cash than it needs, the surplus is swept against the revolver to pay it back down. The revolver is the plug that guarantees cash never goes negative without a financing source.
Mechanically, you forecast every cash inflow and outflow first — operating cash flow, capex, mandatory debt repayments, dividends — and arrive at a cash surplus or shortfall before the revolver. The revolver then moves in the opposite direction to that number, subject to a minimum cash balance the company wants to keep on hand and any borrowing limit on the facility.
Draw = max(0, Minimum cash − Cash available before revolver); Repay = min(Opening revolver, max(0, Cash available before revolver − Minimum cash))One side funds shortfalls, the other sweeps surpluses. Together they keep cash at or above the minimum without ever over-repaying.
Why the plug lives in financing The revolver is the financing answer to an operating question: 'did the business cover itself this period?' That's why it belongs in the debt schedule and the financing section — it is the lever that absorbs every timing mismatch between cash generated and cash needed.
How cash leaves the business for shareholders, and what it does to equity and share count.
Not all the cash a company generates is reinvested or used to pay down debt. The rest is returned to shareholders, and there are two main routes: dividends and share buybacks. Both are financing outflows, both reduce equity, but they behave differently on the statements and have different implications for per-share metrics.
Dividends are usually modelled from a payout ratio — a fraction of net income paid out as cash — or from a fixed dividend per share. Buybacks repurchase shares for cash, which shrinks the share count and lifts earnings per share even when net income is flat. A buyback retires equity directly; a dividend simply distributes earnings that would otherwise have accumulated in retained earnings.
Dividends = Payout ratio × Net incomeRetained earnings then grow by (Net income − Dividends), which is what links the income statement to equity on the balance sheet.
Shares repurchased = Buyback spend / Share price; New share count = Prior shares − Shares repurchasedFewer shares spread the same net income over a smaller base, so EPS rises mechanically.
| Dimension | Dividend | Buyback |
|---|---|---|
| Cash flow | Financing outflow | Financing outflow |
| Share count | Unchanged | Falls |
| EPS effect | Neutral | Accretive (fewer shares) |
| Equity | Reduces retained earnings | Reduces equity (treasury) |
| Signal | Commitment to a steady payout | Flexible, opportunistic |
Don't let returns outrun the cash Dividends and buybacks compete with capex and debt repayment for the same dollars. Over-promise on capital returns and the revolver has to draw to fund them — financing distributions with debt, which a careful model will make obvious.
Interest depends on debt, debt depends on cash, cash depends on interest — a loop.
Capital structure is where the model bites its own tail. Interest expense depends on how much debt is outstanding. The amount of debt — specifically the revolver — depends on how much cash the business has. But cash depends on net income, and net income depends on interest expense. Trace the chain and you get a loop: interest → cash → debt → interest. This is the famous circular reference in three-statement modelling.
Interest → Net income → Cash flow → Revolver balance → InterestEach arrow is a genuine dependency, which is exactly why the calculation chases its own output.
Why iterative calc is dangerous on a desk Iterative calculation is a per-file Excel setting that doesn't travel with the workbook reliably. Open the model on a machine where it's off and every circular cell shows an error. Many institutions ban it outright and use a circularity switch or beginning-balance interest instead.
Solved for you in the engine In The Cash Flow Projector the capital-allocation engine resolves the debt → interest → cash loop internally — there is no iterative-calc toggle to manage and no broken-circularity errors to chase. You set the policy (leverage, minimum cash, payout) and the revolver and interest settle consistently every time you change an assumption.