how a waterfall payment works
imagine a waterfall cascading down into vertically aligned buckets the water represents money and the buckets represent creditors the water fills the first bucket first the second bucket will fill only after the first is full as water flows more buckets are filled in the order in which they appear typically bucket sizes size of debt decrease as the water descends this is likely because paying off large debts reduces the risk of insolvency and frees up cash for operations capital expenditures and investments for example this type of plan works best for a company repaying more than one loan assume this company has three operating loans each with different interest rates the company makes principal and interest payments on the costliest loan and makes only interest payments on the remaining two once the most expensive loan is paid off the company can make all interest and principal payments on the next more expensive loan the process continues until all loans are repaid example of waterfall paymentsto demonstrate how a waterfall payment scheme works assume a company has taken loans from three creditors creditor a creditor b and creditor c the scheme is structured so that creditor a is the highest tiered creditor while creditor c is the lowest tiered creditor the arrangement for what the company owes each of the creditors is as follows assume in year one the company earns 17 million it then pays off the entire 15 million owed to creditor a leaving it with 2 million to pay off further debts since the priority structure is still in place this 2 million must be applied to creditor b assume the company pays 1 million to creditor b for interest and 1 million to creditor b for the principal the result after year one is as follows if in year two the company earns 13 million it could then pay off the remaining obligation to creditor b and begin paying off creditor c the result after year two is as follows this example was simplified to show the mechanics of a waterfall payment scheme in reality some waterfall schemes are structured so minimum interest payments are made to all tiers during each payment cycle 