Working Capital Cycle and Leverage in a Distressed Textile Unit
Kaveri Textiles Ltd has revenue of INR 120 crore, EBITDA of INR 12 crore, and a net profit of INR 3 crore. Its current assets are INR 40 crore (inventory INR 18 crore, receivables INR 16 crore, cash INR 6 crore) and current liabilities are INR 30 crore (payables INR 20 crore, short-term debt INR 10 crore). The company proposes a INR 15 crore term loan at 12% to fund a new unit, which will add INR 4 crore of EBITDA but also INR 3 crore of depreciation and INR 1.2 crore of interest. The bank requires a debt-service coverage ratio of at least 1.5 times and a current ratio of at least 1.33. The promoter asks whether the project should proceed and how to improve the ratios without fresh equity.
1. Compute the key ratios before and after the loan, and advise on the bank's covenants.
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Before the loan.
- Current ratio = 40/30 = 1.33, exactly at the covenant.
- Net debt/EBITDA: assuming existing debt of INR 10 crore, 10/12 = 0.83 times.
- Interest cover = 12/ (interest on existing debt, say INR 1.2 crore) = 10 times.
After the loan.
- Current ratio: the term loan is long-term, so current liabilities are unchanged, but cash rises by INR 15 crore, giving 55/30 = 1.83. If the loan is used to pay for the new unit, cash falls and fixed assets rise; the current ratio then returns towards 1.33.
- EBITDA rises to INR 16 crore; interest rises by INR 1.2 crore to INR 2.4 crore; interest cover = 16/2.4 = 6.7 times, still comfortable.
- DSCR: EBITDA of INR 16 crore against interest of INR 2.4 crore plus scheduled principal, say INR 3 crore, gives 16/5.4 = 2.96 times, above 1.5.
Advice. The project clears both covenants on these numbers, but the current ratio is thin and depends on the loan not being spent on current assets. The bank will look at the post-disbursement position, not the interim cash. The company should proceed only if the receivables cycle is tightened first.
2. How can the ratios be improved without fresh equity, and what are the risks of each lever?
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Four levers are available, each with a cost.
- Receivables. INR 16 crore of receivables on INR 120 crore of revenue implies a collection period of about 49 days. Cutting it to 40 days releases roughly INR 3 crore of cash, improving the current ratio and reducing short-term debt. Risk: aggressive collection can damage dealer relationships.
- Inventory. INR 18 crore of inventory implies about 55 days. Reducing to 45 days releases about INR 3 crore. Risk: stock-outs and lost sales.
- Payables. Stretching payables from 20 to 24 crore improves the current ratio but raises supplier risk and may breach credit terms. This is the weakest lever.
- Refinancing short-term debt. Converting INR 10 crore of short-term debt into a working capital term loan improves the current ratio because current liabilities fall, without changing the economics. Risk: the bank may treat it as a sign of stress.
A combination of receivables and inventory release of about INR 6 crore, plus refinancing, lifts the current ratio to roughly 1.7 without fresh equity. The promoter should present a cash-flow plan to the bank rather than rely on the covenant being met on day one.