Case 034Credit analysis and lendingCore
A pharma distributor asks its bank for a working capital limit. Size the limit under the second method of lending and under the turnover method, and say which you would trust.
1The situation
Aadinath Pharma Distributors buys medicines from manufacturers and sells to chemists and hospitals. Annual sales are Rs 600 crore and cost of goods sold Rs 540 crore. It holds 45 days of inventory, measured on cost of goods, and gives customers 60 days of credit. Manufacturers give it 30 days, measured on cost of goods. Other current liabilities, such as statutory dues and advances, are Rs 10 crore. It holds no other current assets.
Two frameworks have long been used by Indian banks: the second method of lending from the Tandon Committee, and the turnover method from the Nayak Committee. Banks now apply their own assessment policies, so the current norms of the lending bank should be confirmed.
2Your task
Build the current assets and liabilities, size the bank limit under each method, and say which number you would lend against.
Quick check
The turnover method lends 20% of sales. Is that more or less than Aadinath's actual working capital gap?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
The second method gives a limit of about Rs 69.5 crore; the turnover method gives Rs 120 crore, more than the whole Rs 110.8 crore gap. Current assets are Rs 165.2 crore, trade credit and other liabilities fund Rs 54.4 crore, and the promoter must bring 25% of current assets, Rs 41.3 crore. Lend against the second method: it is built from this balance sheet, while the turnover shortcut assumes a longer cycle and suits small borrowers.
Step 1What does a working capital limit actually fund?
The gap between what the business has tied up and what its suppliers fund for free. A shopkeeper with Rs 10 lakh of stock and dues from customers, who owes wholesalers Rs 4 lakh, needs Rs 6 lakh from somewhere. The bank funds part of that gap and the owner funds the rest as a marginThe share of the working capital gap the borrower must fund from its own long-term money, so the bank never finances the whole cycle.. So the first job is to build current assets and current liabilities from the days given.
| Line | Basis | Rs crore |
|---|---|---|
| Inventory | 45 days of COGS | 66.6 |
| Receivables | 60 days of sales | 98.6 |
| Current assets | 165.2 | |
| Trade creditors | 30 days of COGS | 44.4 |
| Other current liabilities | given | 10.0 |
| Current liabilities, excluding the bank | 54.4 | |
| Working capital gap | 110.8 |
Step 2How does the second method size the limit?
It asks the borrower to fund a quarter of current assets from long-term money and lets the bank fund the rest of the gap. Bank finance equals 75% of current assets less current liabilities: 0.75 times 165.2 less 54.4, which is Rs 69.5 crore. The promoter's margin is Rs 41.3 crore. The method's strength is that it is tied to the actual balance sheet, so a longer receivable period raises the limit and a stretch on suppliers lowers it.
| CA | current assets: inventory plus receivables |
| CL | current liabilities other than bank borrowing |
| 0.75 | the bank funds at most three quarters of current assets, less what suppliers already fund |
Step 3And the turnover method?
It skips the balance sheet. It assumes working capital needs are 25% of annual sales, of which the borrower brings 5% of sales and the bank lends 20%. For Aadinath that is Rs 120 crore of bank finance, more than the entire Rs 110.8 crore gap. The method was designed as a quick test for small borrowers, whose cycles are often about three months; Aadinath's gap is only 18.5% of sales, and its cash cycle is 75 days, so the shortcut overstates the need.
Step 4Which number would you lend against?
The second method's Rs 69.5 crore, checked against the business. A limit larger than the gap does not finance working capital; it finances something else, and the bank should ask what. Then test the inputs: are 60 days of receivables collectible, and how much of the inventory is near expiry, which matters in pharma distribution? A drawing power calculation that applies margins to stock and debtors each month keeps the limit tied to real assets. Close with the caveat the setup asks for: these are historical frameworks, and the lending bank's current assessment policy decides the final number.
Where candidates lose it
The common mistake is mixing bases: computing inventory and payables on sales rather than on cost of goods. Days of inventory and payables are measured on what the goods cost, and using sales overstates both.
The second is accepting the turnover number because it is larger and easier. A limit above the actual gap means the bank is funding something other than the trading cycle, often a diversion of funds.
What the interviewer asks next
- Customers stretch to 90 days. What happens to the gap and to the second method limit?
- What is drawing power, and how would the bank calculate it each month?
- What would the first method of lending give, and why is it more generous?
Asked at Deutsche Bank, Sales and Trading, New York, 2024 (Wall Street Oasis): The case study was relatively simple, focused on lending to a middle-market corporate.
Company names and figures are illustrative.