Case 058Working capital and cash flowCore

Tulsikunj Naturals will grow revenue 60% from Rs 200 crore to Rs 320 crore at an 8% EBITDA margin, with working capital at 25% of revenue. What is next year's free cash flow, and at what growth rate does it turn positive?

The situation

Tulsikunj Naturals makes herbal personal care products and sells them through distributors and modern trade. Revenue is Rs 200 crore and the plan is Rs 320 crore next year, 60% growth. Net working capital, mostly receivables from modern trade and inventory, runs at 25% of revenue.

EBITDA margin is 8%. Depreciation is Rs 5 crore a year, tax is 25% of operating profit, and capex runs at 3% of revenue. The founder says the business is profitable and should not need fresh money.

Your task

Compute next year's free cash flow, and find the growth rate at which free cash flow is exactly zero.

Quick check

Is next year's free cash flow positive or negative?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Free cash flow is about minus Rs 19 crore next year, and it turns positive only below about 16.5% growth. EBITDA of Rs 25.6 crore less Rs 5.15 crore of tax and Rs 9.6 crore of capex leaves about Rs 10.9 crore, but working capital must grow by Rs 30 crore. Each point of growth ties up Rs 0.5 crore of working capital and earns back only Rs 0.06 crore, so 60% growth must be funded from outside.

Step 1Why can a profitable business run out of cash?

Because growth has to be paid for before it is paid for by customers. Every extra rupee of sales needs 25 paise of stock and receivables sitting in the business, and that money leaves before the profit arrives. A tailor who takes a large wedding order has to buy all the fabric up front and gets paid on delivery: the order is profitable and the tailor still has to borrow. Tulsikunj's net working capitalInventory plus receivables less payables: the money tied up in running the business day to day. is 25% of revenue, which is high, so it feels this sharply.

Step 2What is next year's free cash flow?

Work down from EBITDA. Revenue of Rs 320 crore at 8% gives EBITDA of Rs 25.6 crore. Operating profit after Rs 5 crore of depreciation is Rs 20.6 crore, so tax is Rs 5.15 crore. Capex is 3% of Rs 320 crore, Rs 9.6 crore. Working capital rises from 25% of Rs 200 crore to 25% of Rs 320 crore, Rs 50 crore to Rs 80 crore, a Rs 30 crore outflow that is larger than EBITDA itself. Free cash flow is 25.6 less 5.15, less 9.6, less 30: minus Rs 19.15 crore.

Profitable and growing 60%, and still burning cash025.6EBITDA-5.15Tax-9.6Capex-30Working capital-19.15Free cash flowRs crore, year ahead, revenue 200 to 320
Tulsikunj's Rs 25.6 crore of EBITDA becomes minus Rs 19.15 crore of free cash flow after Rs 5.15 crore of tax, Rs 9.6 crore of capex and a Rs 30 crore working capital build, so fast growth consumes cash even though the business is profitable.
Step 3At what growth rate does free cash flow turn positive?

Write free cash flow as a function of growth g. Revenue is 200(1 + g). After-tax cash margin less capex is 8% times 0.75 plus the tax shield on depreciation, less 3%, which works out to 3% of revenue plus Rs 1.25 crore. Working capital build is 25% of the Rs 200g crore of new revenue, Rs 50g crore. So free cash flow is 7.25 less 44g crore, which is zero at g of about 16.5%. Below that, growth funds itself; above it, every point of growth needs about Rs 0.44 crore of outside money.

The relationship
FCF(g)=0.03×200(1+g)+1.25−0.25×200g=7.25−44g=0  ⇒  g≈16.5%FCF(g) = 0.03 \times 200(1+g) + 1.25 - 0.25 \times 200g = 7.25 - 44g = 0 \;\Rightarrow\; g \approx 16.5\%
0.03 x 200(1+g)after-tax EBITDA margin of 6% less 3% capex, on next year's revenue
1.25tax saved by Rs 5 crore of depreciation at 25%
0.25 x 200gworking capital tied up by the new revenue
What it says in wordsFree cash flow falls by Rs 0.44 crore for every point of growth and reaches zero at about 16.5% growth.
Every point of growth costs Rs 0.44 crore of cash+10-10-200breakeven 16.5% growthplan: 60%, -19.15no growth: +7.250%20%40%60%Revenue growth next year; free cash flow in Rs crore
Tulsikunj's free cash flow falls in a straight line from plus Rs 7.25 crore at zero growth to minus Rs 19.15 crore at the planned 60%, crossing zero at about 16.5% growth.
Step 4What would you tell the founder?

That the plan needs about Rs 20 crore of funding, or a working capital fix. The most powerful lever is not margin but working capital intensity: at 20% of revenue instead of 25%, next year's free cash flow improves to about minus Rs 3.1 crore. That means tighter credit terms with modern trade, less finished stock, or longer supplier credit. Raising the EBITDA margin by a full point adds only about Rs 2.4 crore after tax. Say the limit too: the figure assumes working capital stays at 25% of sales as the mix shifts, and a move toward modern trade usually pushes that ratio up, not down.

Where candidates lose it

The common miss is treating EBITDA as cash and declaring that a Rs 25.6 crore profit funds the growth. The interviewer is waiting for the working capital line; without it the answer has the wrong sign.

The second is applying 25% to the whole Rs 320 crore of revenue as an outflow, Rs 80 crore, instead of only to the Rs 120 crore increase. The opening Rs 50 crore is already funded.

What the interviewer asks next

  • What working capital percentage would make 60% growth self-funding?
  • Would you fund the gap with a working capital loan or equity, and why?
  • How would a shift from distributors to modern trade change the answer?

Company names and figures are illustrative.