Case 015Portfolio operations and exitsHard
Cash flow build-up for a jeweller: EBITDA Rs 110 crore, Rs 900 crore of gold inventory, a Rs 400 crore gold metal loan, revenue growing 15%. Build cash from EBITDA and show why growth consumes it.
1The situation
Swarnakar Jewels runs 40 jewellery showrooms. Revenue is Rs 2,000 crore and cost of goods Rs 1,825 crore, almost all of it gold. EBITDA is Rs 110 crore, depreciation Rs 10 crore, capex Rs 20 crore for store refits. Gold on the shelves is Rs 900 crore, 180 days of cost of goods; receivables are 10 days of revenue and suppliers are paid in 20 days.
The inventory is financed partly by a Rs 400 crore gold metal loan at 4%, a facility under which a bank lends gold rather than rupees, and a Rs 200 crore term loan at 11%. Tax is 25%. Management plans 15% revenue growth next year and asks for Rs 150 crore of fresh debt. Hold the day counts constant and take gold prices as flat; a real build would stress both.
2Your task
Build next year's free cash flow from EBITDA, show the working capital lines separately, find the growth rate at which cash flow turns negative, and say what the lender should conclude.
Quick check
EBITDA is Rs 110 crore and will grow 15%. Before building anything: is next year's free cash flow positive?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
At 15% growth free cash flow is about minus Rs 79 crore: EBITDA of Rs 126 crore less Rs 20 crore of tax, Rs 38 crore of interest, Rs 20 crore of capex and Rs 128 crore of working capital, of which the gold build is Rs 135 crore. With no growth the same business generates Rs 36 crore. Cash turns negative above about 4.7% growth. The Rs 150 crore request is the growth plan's working capital, and the lender is being asked to fund gold, which argues for a gold metal loan rather than a term loan.
Step 1Why is EBITDA such a poor guide to cash here?
Think of a sweet shop that must stock six months of ingredients before it sells a single box: the more it plans to sell next year, the more it has to buy this year. Swarnakar holds 180 days of gold, Rs 900 crore, so every extra rupee of sales needs about 45 paise of gold bought in advance, and 15% growth on the stock is Rs 135 crore, more than the whole year's EBITDA. Receivables are small, 10 days, and suppliers fund 20 days, so the net working capital buildThe extra cash tied up in stock and customer credit, net of supplier credit, when a business grows. It is spent before the sales it supports are made. is Rs 128 crore.
Step 2What does the build-up look like line by line?
EBITDA grows with revenue to Rs 126.5 crore. Interest is 4% on the Rs 400 crore gold loan and 11% on the Rs 200 crore term loan, Rs 38 crore. Tax is 25% of EBITDA less depreciation less interest, Rs 19.6 crore. Capex Rs 20 crore. Then the working capital: inventory up Rs 135 crore, receivables up Rs 8.2 crore, payables up Rs 15 crore, a net Rs 128 crore, and free cash flow is minus Rs 79.3 crore.
| Rs crore, next year | No growth | 15% growth |
|---|---|---|
| EBITDA | 110.0 | 126.5 |
| Tax at 25% after depreciation and interest | (15.5) | (19.6) |
| Interest: gold loan 4%, term loan 11% | (38) | (38) |
| Capex | (20) | (20) |
| Inventory build, 180 days of extra COGS | 0 | (135.0) |
| Receivables build | 0 | (8.2) |
| Payables increase | 0 | 15.0 |
| Free cash flow | 36.5 | (79.3) |
Step 3At what growth rate does the cash run out?
Each point of growth adds Rs 0.82 crore of after-tax EBITDA and takes Rs 8.55 crore of working capital, a net cost of about Rs 7.7 crore per point. Starting from Rs 36 crore at zero growth, free cash flow crosses zero at about 4.7% growth; everything faster has to be borrowed. That is the structural fact of the business: it can grow slowly on its own cash, or quickly on someone else's.
Step 4What should the lender conclude?
That the Rs 150 crore request is working capital for gold, not a loan against earnings. Lend it as an increase in the gold metal loan, secured on the inventory it buys and priced like gold, rather than as a term loan the business repays from Rs 36 crore of standstill cash flow. Total debt would reach Rs 750 crore, 5.9x EBITDA, which only works because the gold is liquid. The limit of this build is the flat gold price and the fixed 180 days: a 10% fall in gold marks Rs 90 crore off the collateral, and a slow season adds days. A lender who does not stress both has not finished the case.
Where candidates lose it
The common loss is building cash flow as EBITDA less tax, interest and capex and stopping, which gives a comfortable positive number. In a business with half a year of stock, the working capital line is the biggest line, and it carries a minus sign whenever revenue grows.
The second miss is computing the inventory build on revenue rather than cost of goods, or using the 15% on EBITDA only. Stock is held at cost; 15% growth means 15% more gold at cost, Rs 135 crore.
What the interviewer asks next
- Gold prices rise 10% during the year. What does that do to inventory, the gold loan and cash?
- Management offers to cut inventory to 150 days. How much cash does that release, and what does it do to the breakeven growth rate?
- Why is a gold metal loan cheaper than a term loan, and what risk does the borrower take on with it?
Asked at HPS Investment Partners, Investments, London, 2025 (Wall Street Oasis): General conversation, deal experience discussion, CF build-up for one of my deal
Asked at HPS Investment Partners, Investments, London, 2025 (Wall Street Oasis): then 2 EDs (deal experience discussion, CF build-up for one of my deal), then case study
Company names and figures are illustrative.