What Does Cash Sweep Mean?
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.
Divestopedia Explains Cash Sweep
A cash sweep is an automatic bank process where funds are transferred from an investment account to a deposit account or vice versa with the purpose of minimizing the risk of incurring more or higher interest rates from their debt. It can be done within the same banking institution or from one bank account to another bank account from another institution. Funds that are added in the sweep account are transferred according to the specifications of the customer and most cash sweeps occur once a day.
The amount of cash available for a cash sweep is calculated as follows:
Cash Sweep = Total Cash at Hand – Minimum Cash Balance for Operations + Debt Service Cash Flow
This can be furthered explained in this sample balance sheet from Company ABC:
Beginning cash balance (Total cash at hand)
(-) Minimum cash balance for operations
(+) Cash flow available for debt service
Cash available for sweep
Cash Sweep = $326,800,000 - $103,200,000 + $68,200,000 = $291,800,000
Companies that use cash sweep accounts can ultimately improve their debt-to-equity ratio by paying off their debts earlier than what was scheduled. This in turn improves their financial stability and their ability to secure venture capital financing.
In other cases, a lender may require in the loan agreement that the borrower use a cash sweep account in order to pay down the debt more quickly over time. This type of provision is commonly used by lenders who loan to borrowers that work in volatile industries, such as energy or commodities. The cash sweep effectively requires the borrower to pay down a portion of the loan using their excess cash in addition to the regular loan payments. This can help to offset lower loan payments that may be made during years of lean cash flow. Borrowers can also extend this provision to lenders when they want to increase the length of a loan.
For individuals, cash sweep accounts should not be viewed as long-term investments. The money is only invested for a very short period of time and then an interest or dividend payment is made at the end of the month. This type of account is therefore simply a short-term money management tool.