Working Capital Increase for a Packaging Manufacturer
A packaging manufacturer with annual revenue of 4.8bn requests a 500m increase in its working capital facility, taking total funded exposure to 1.7bn. Audited accounts show 18% revenue growth, EBITDA of 720m (15% margin), and PAT of 210m. Cash flow from operations was negative 150m after a 380m build-up in related-party receivables due from a logistics company owned by a director. Receivables days rose from 75 to 120 and inventory days from 60 to 95, while payables were stretched from 45 to 30 days. Capex of 400m was funded by short-term borrowings. The borrower proposes no new equity. The relationship manager argues that EBITDA covers interest 4.2 times and the sector is growing. Credit policy requires a minimum DSCR of 1.5x on funded debt and prohibits more than 10% of receivables from related parties without credit committee approval.
1. Recalculate the borrower's sustainable debt service capacity and identify the financial statement red flags hidden by the EBITDA argument.
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Sustainable debt service capacity. EBITDA of 720m is not cash available for debt service. CFO was negative 150m. Even using EBITDA before working-capital changes, interest coverage of 4.2x implies interest of about 171m, but DSCR must also cover principal. If scheduled principal is 200m, DSCR is 720/(171+200)=1.94x before adjusting for the related-party accrual and inventory build; after adjusting for the 380m related-party receivable, recurring cash available for debt service is negative. The proper test is (CFO + interest paid - maintenance capex) / (interest + scheduled principal), which is below zero.
Red flags. (1) Negative CFO despite reported profit: earnings are not converting to cash. (2) Related-party receivables of 380m are about 24% of total receivables (120/365 x 4.8bn = 1.58bn), breaching the 10% policy limit without approval; this may be disguised equity extraction or revenue inflation. (3) The cash conversion cycle has lengthened from 90 days (75+60-45) to 185 days (120+95-30), an increase of 95 days. At daily revenue of about 13.15m, that absorbs about 1.25bn, explaining why short-term debt funded capex and why the 500m request is insufficient. (4) Stretching payables to 30 days while receivables and inventory balloon signals supplier stress and possible default risk. (5) No equity contribution means all risk is bank-funded.
2. Recommend approval, decline, or conditional approval of the 500m increase, with specific conditions and monitoring triggers.
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Recommendation: decline the 500m request as structured; offer conditional support only after remediation. The borrower fails the policy limit on related-party receivables and has negative CFO, so additional exposure would fund a working-capital hole, not growth. A conditional approval could be considered for a smaller amount (e.g., 150-200m) if: (a) the 380m related-party receivable is collected or converted to equity and the director resigns from the supplier; (b) the borrower injects at least 250m equity; (c) receivables days fall below 90 and inventory days below 70; (d) the facility is structured as a borrowing-base revolver with monthly monitoring; (e) personal guarantees and a cash sweep are added; (f) covenants: DSCR >=1.5x, current ratio >=1.2x, no dividends, related-party transactions <5% of receivables. Monitoring triggers: overdraft utilization >90% for 30 days, receivable days >100, negative CFO for two quarters, any covenant breach, or auditor qualification. Escalate to credit committee because the policy waiver is required. Do not let relationship pressure override cash-flow reality.