Simple Credit Cash-Flow Test
Reduce every investment to cash out, repayment conditions, timing, and spread.
- Difficulty
- Easy
- Time to result
- ~days to results
- Steps
- 7
- Confidence
- 96%
This framework strips a credit opportunity down to its essential exchange of money. Begin with the amount being disbursed, then identify the precise events, counterparties, and mechanisms that determine whether and how it returns. Examine disbursement conditions as carefully as repayment conditions because poor controls at funding can undermine an otherwise attractive structure. Next, measure the duration between cash leaving and returning, since time changes both risk and annualized performance. Finally, compare the total expected recovery with all capital and costs advanced. If an experienced presenter cannot make these mechanics understandable after one or two explanations, treat that opacity as a warning rather than evidence of sophistication. The test does not replace full underwriting; it establishes whether the proposed investment has coherent economics worth investigating.
Origin
Eva Shang presented this as the central lesson she learned while building Legalist's alternative-credit funds. Extracted from Masters in Business.
Core principles
- 01Translate jargon into observable cash flows.
- 02Define every condition governing disbursement and repayment.
- 03Understand both how capital leaves and how it returns.
- 04Minimize the time between funding and repayment.
- 05Maximize the risk-adjusted difference between cash out and cash back.
- 06Reject structures that remain unintelligible after a clear explanation.
How to run it
- 1
Map Cash Out
Record the principal, fees, follow-on obligations, and other capital that may leave the investor.
Pro tip Include contingent funding commitments rather than only the initial advance.
Watch out Headline principal can understate the investor's maximum exposure.
- 2
Define Repayment Conditions
List the exact events that must occur before capital is returned, including performance, settlement, collection, or contractual milestones.
Pro tip Rewrite each condition in plain language that a non-specialist can test.
Watch out Avoid vague claims that repayment occurs when an asset merely performs well.
- 3
Trace the Repayment Path
Identify who pays, where the money flows, what controls protect it, and which parties have priority.
Pro tip Draw a simple counterparty-and-cash-flow map.
Watch out A promised return is weak if the collection mechanism is unclear.
- 4
Audit Disbursement Controls
Determine who authorizes each advance, what evidence is required, and whether capital can be stopped when conditions deteriorate.
Pro tip Match every disbursement trigger to objective documentation.
Watch out Loose funding controls can expand exposure after the original thesis has failed.
- 5
Measure Duration
Estimate the base, upside, and downside timelines between funding and repayment.
Pro tip Convert total returns into annualized returns across multiple duration scenarios.
Watch out A large nominal gain may be unattractive if repayment takes many years.
- 6
Calculate the Spread
Compare expected cash returned with principal, fees, expenses, losses, and the cost of time.
Pro tip Use conservative recoveries and delayed repayment in the base case.
Watch out Do not confuse gross proceeds with net investor return.
- 7
Apply the Clarity Gate
Proceed only if the complete mechanism can be explained coherently after one or two careful explanations.
Pro tip Ask the presenter to describe the deal without industry jargon.
Watch out Complexity may hide weak incentives, excessive fees, or misunderstood risk.
In the wild
A contractor wants an advance against invoices owed by a state agency. The investor maps the initial advance, confirms that payment will come directly from the government, verifies the facility's eligibility rules, estimates a 90-to-120-day collection period, and calculates the net spread after fees and delays. The structure remains understandable without specialist terminology.
→ The opportunity passes the clarity gate and can proceed to detailed operational and legal diligence.
Common mistakes
Mistaking Jargon for Sophistication
Technical language can conceal a cash-flow mechanism that is weak, expensive, or poorly understood.
Ignoring Time to Repayment
Comparing only dollars invested and dollars recovered can make a slow investment look more attractive than it is.
Reviewing Repayment but Not Disbursement
Investors often study how they get paid while overlooking the controls governing when additional capital can leave.
Is it for you?
Best for
It is best for investors, founders, and allocators conducting an initial sanity check on a credit opportunity.
Not ideal for
It is not a substitute for detailed legal, tax, accounting, operational, or probabilistic due diligence.
From the transcript
“I give you a certain amount of money, and you give it back to me if X, y Z, and you have to understand under…”
“you try to minim the gap in time and maximize the difference between what you put out and what you get back.”
“if I can't understand someone after having it explained to me once or twice, then it probably doesn't make sense and they're just pretending to…”
From the episode
Eva Shang on Litigation Finance Funds
Eva Shang