Case 028Debt capacity and loan structuringWarm up
Hemantra Agro has sales of Rs 1,200 crore, inventory of 90 days, receivables of 45 days and payables of 30 days. What working capital does it carry, and how large a cash credit line would a bank allow at a 25% margin?
1The situation
Hemantra Agro buys pulses and oilseeds from farmer groups, cleans and packs them, and sells to wholesalers. Sales are Rs 1,200 crore a year. It holds 90 days of inventory, gives customers 45 days to pay and takes 30 days from its own suppliers.
It has asked its bank for a cash credit facility, a revolving line secured on stock and receivables. The bank requires the borrower to fund 25% of the working capital from its own long-term money, the margin, and lends against the rest.
2Your task
Work out the working capital requirement and the drawing power, and say what would make you size the line differently.
Quick check
Roughly how large a line does the bank allow?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Hemantra carries about Rs 345 crore of working capital, and a bank would allow drawing power of about Rs 259 crore. The net cycle is 90 plus 45 minus 30, or 105 days, which on Rs 1,200 crore of sales is Rs 345.2 crore. The borrower funds a 25% margin, Rs 86 crore, and the bank finances the remaining 75%.
Step 1Why does a business need a line for working capital at all?
A tailor buys cloth, stitches for weeks and waits for the customer to pay, while the cloth merchant wants paying sooner. Money is stuck in the gap. Working capital is the cash tied up between paying for goods and being paid for them, and the cash conversion cycleInventory days plus receivable days minus payable days: how long each rupee is locked in the business before it comes back. measures that gap in days. Hemantra pays for pulses, holds them 90 days, then waits 45 more for its customers, while its own suppliers fund only 30 days.
Step 2How does the bank turn the cycle into a limit?
Convert each line to rupees: inventory Rs 295.9 crore, receivables Rs 147.9 crore, payables Rs 98.6 crore. Stock plus receivables minus payables is Rs 345.2 crore, and 75% of it, Rs 258.9 crore, is the drawing powerThe amount a borrower may actually draw on a working capital line at a given moment, recomputed from its latest stock and receivables statement less the margin.. The margin exists so the promoter has money at risk alongside the bank; if stock values fall, the margin absorbs the first loss. Indian banks set margins by policy and asset type, so confirm the current norm for a given lender.
| Rs crore | Sales basis | Cost basis (COGS 80% of sales) | Harvest peak, 150 days of stock |
|---|---|---|---|
| Inventory | 295.9 | 236.7 | 493.2 |
| Receivables | 147.9 | 147.9 | 147.9 |
| Less payables | (98.6) | (78.9) | (98.6) |
| Working capital | 345.2 | 305.8 | 542.5 |
| Drawing power at 75% | 258.9 | 229.3 | 406.8 |
Step 3What would make you size the line differently?
Two refinements, both visible in the table. First, stock and payables are really held at cost, not selling price. If cost of goods is 80% of sales, the same days give Rs 306 crore of working capital and Rs 229 crore of drawing power, so the sales basis overstates the need by about Rs 30 crore. Second, an agro processor buys most of its crop in a few post-harvest months. If stock peaks at 150 days, working capital reaches Rs 542 crore and the business needs about Rs 407 crore for part of the year.
That points to a structure rather than one number: a regular limit sized on the average cycle, plus a seasonal limit for the harvest months that must be cleared once the stock is sold. Drawing power is recomputed monthly from stock statements, so the bank also wants stock audits and an ageing of receivables, since a debt 120 days old is rarely worth lending against.
Where candidates lose it
The first loss is forgetting payables. Adding inventory and receivables gives 135 days and a line about Rs 100 crore too large, lending the bank's money against stock suppliers are already financing.
The second is stopping at the working capital figure. The question asked for the line, and the line is working capital less the borrower's margin.
What the interviewer asks next
- Receivable days rise to 75 because two wholesalers pay late. What happens to drawing power, and should the bank be pleased?
- How would you check that the stock statement is honest?
- Why do banks exclude receivables older than 90 days from drawing power?
Company names and figures are illustrative.