Case 002Corporate credit and ratingsWarm up

A trader with Rs 365 crore of sales asks the bank to renew a Rs 70 crore working capital limit. Work out how much working capital the business actually needs and decide whether the limit is adequate.

The situation

Kanvel Traders distributes building materials. Annual revenue is Rs 365 crore, spread evenly through the year. Stock sits for 60 days on average before it is sold, customers take 90 days to pay, and Kanvel pays its own suppliers after 45 days.

Kanvel has a working capital limit of Rs 70 crore from your bank, which it asks to renew at the same size. For simplicity, measure all three day counts against sales; the bank's policy expects the borrower to fund an illustrative 25% of the working capital gap from its own long-term money.

Your task

What is Kanvel's cash conversion cycle, how much working capital does that tie up, and is the Rs 70 crore limit adequate?

Quick check

Before calculating: how much working capital does Kanvel need to fund?

Worked solution

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

30-second answerThe answer to give first

Kanvel's cash conversion cycle is 105 days, which ties up about Rs 105 crore against a Rs 70 crore limit. Even after Kanvel funds a 25% margin itself, the bank's share is about Rs 79 crore, so the limit is too small. Before enhancing it, ask why customers take 90 days: cutting that to 60 would bring the need to Rs 75 crore and fit the existing limit.

Step 1Why does the cash cycle, not sales, decide how much a trader borrows?

Picture a vegetable seller who buys at dawn on credit, sells by noon for cash and pays the wholesaler in the evening. She needs almost no borrowed money, whatever her turnover. Now make her customers pay next month. Borrowing need is set by how long cash is tied up between paying for goods and being paid for them, multiplied by how much is sold each day. That span is the cash conversion cycleDays of stock plus days customers take to pay, less days the business takes to pay suppliers: how long each rupee is out of the business..

Kanvel's money is out for 150 days, 60 in stock and 90 waiting for customers, and suppliers fund the first 45, leaving a 105 day gap that ties up Rs 105 crore against a Rs 70 crore limit.

Step 2How do the numbers work?

Sales of Rs 365 crore a year are Rs 1 crore a day, which is why the case uses 365. 60 plus 90 less 45 is 105 days, and 105 days of sales is Rs 105 crore of working capital. If Kanvel brings its 25% margin, Rs 26.25 crore, the bank is asked for Rs 78.75 crore. The current limit covers Rs 70 crore of it, so the business is short by about Rs 8.75 crore even on the bank's own policy, and by Rs 35 crore if Kanvel brings nothing.

Case	Cycle, days	Need, Rs crore	Bank share at 75%	Fits Rs 70 crore?
As reported	105	105	78.75	No
Receivables cut to 60 days	75	75	56.25	Yes

At the reported 90 receivable days Kanvel needs Rs 105 crore and the bank's share is Rs 78.75 crore, above the limit; at 60 days the need falls to Rs 75 crore and the bank's share to Rs 56.25 crore, inside it.

Step 3Would you simply raise the limit?

Not before asking about the 90 days. A long receivable period can be the trade's norm or a sign that some customers are not paying, and the two call for opposite decisions. Ask for the debtor ageing: how much is over 90 days, and to whom. If a few large builders are slow, raising the limit finances their stress with the bank's money. If the whole book genuinely runs on 90 day terms, an enhancement to about Rs 79 crore, with drawing power tied to monthly stock and debtor statements, is the right size.

The limitation to say out loud: the case measures stock and payables against sales. Stock is really held at cost, so on a cost basis the need is somewhat lower. Say the simplification, then show you know which way it cuts. The closing view: the Rs 70 crore limit is inadequate on today's cycle, and the enhancement is conditional on what the ageing shows.

Where candidates lose it

Candidates size the limit off sales, say a fixed fraction of turnover, and never compute the cycle. Two traders with identical sales can need very different amounts, and the day counts are what separate them.

The other loss is adding stock and receivables and forgetting that suppliers fund part of the cycle. That overstates the need by Rs 45 crore here and makes an adequate limit look badly short.

What the interviewer asks next

Kanvel's suppliers cut their credit to 30 days. What happens to the need?
What is drawing power, and why does a bank tie the limit to a monthly stock statement?
Sales grow 20% with the same cycle. How much more working capital does Kanvel need?

Company names and figures are illustrative.