The Season That Eats the Cash
Meera Udyog, a footwear-component maker at Agra, sells ₹4.2 crore a year. Seventy per cent of sales fall between September and January, when it supplies festive-season orders. Its balance sheet shows inventory held for 78 days, receivables collected in 45 days because buyers demand credit, and payables paid in 15 days because suppliers insist on near-cash terms. The current ratio is 1.15 and the bank's ₹80 lakh cash-credit limit is used up to 92 per cent during the peak. A term loan carries an EMI of ₹58,000 a month, and interest cover is 1.6 times. Debt-equity is already 1.8:1. The owner wants ₹1.5 crore to add a moulding line that would cut job-work costs and raise capacity by 40 per cent. He can either take fresh debt at 11.5 per cent, or bring in an equity partner who wants 26 per cent of the company and a board seat.
1. Compute the net operating cycle and estimate the working capital locked in it. What does the number tell you, and which two remedies would you act on first?
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Calculation. Gross operating cycle = inventory period + receivables period = 78 + 45 = 123 days. Net operating cycle = 123 − 15 = 108 days.
Money involved. Daily sales = ₹4.2 crore ÷ 365 ≈ ₹1.15 lakh. Cash locked for 108 days ≈ 108 × ₹1.15 lakh ≈ ₹1.24 crore - against a cash-credit limit of ₹80 lakh used to 92 per cent. The business is funding a 108-day cycle with an 80-day facility, which is why the peak feels like a crisis every year.
What it means. The problem is not sales volume but the cycle length. Each day shaved off releases roughly ₹1.15 lakh.
First two remedies:
- Payables: negotiate 30 days instead of 15. Fifteen extra days releases about ₹17 lakh and costs only the loss of any cash discount, which is usually cheaper than overdraft interest.
- Receivables: invoice discounting or factoring for peak orders, and a 30-day credit limit. Cutting 45 to 30 days releases another ₹17 lakh; where buyers refuse, factor those invoices rather than fund them on the cash-credit limit.
Reducing inventory from 78 to 60 days would release a further ₹20 lakh, but only if the moulding line's job-work savings are real.
2. Advise on funding the ₹1.5 crore moulding line: fresh debt at 11.5 per cent or equity for 26 per cent. Give the reasoning, not just a verdict.
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Two different needs are being confused. A moulding line is a fixed asset with a long life; it should be financed by long-term funds, not by a cash-credit limit already 92 per cent drawn.
Case against fresh debt. Debt-equity is 1.8:1 and interest cover is only 1.6 times - a thin cushion. ₹1.5 crore at 11.5 per cent adds about ₹17.25 lakh of interest a year, falling due every month including June and July when sales are weakest. Debt is a fixed obligation; the firm's cash flow is seasonal. One bad festive season and the coverage ratio falls below 1.
Case for equity. An equity partner brings permanent money, improves the debt-equity ratio, and improves the bank's willingness to keep the cash-credit line. The cost is 26 per cent ownership and a board seat - control, not cash.
Recommendation. Prefer equity or a quasi-equity instrument if the partner brings distribution or technical capability, but negotiate the stake down or structure it as compulsorily convertible instruments. If debt is chosen, match tenure to the asset, seek a moratorium over the lean months, and first repair the operating cycle - a ₹1.5 crore asset on top of a 108-day cycle will simply consume more working capital.
3. The accountant proposes closing the peak-season gap by paying suppliers after 45 days and delaying GST and provident-fund remittances. Evaluate this proposal.
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It converts a financing problem into a legal and supply problem, and the arithmetic is deceptive.
GST. Tax collected is the government's money held in trust. Late remittance attracts interest at 18 per cent a year plus possible penalty - costlier than the 11.5 per cent the owner is being offered, and it can freeze input credits.
Provident fund and ESI. Delayed deposits attract interest and damages, and repeated default invites prosecution. This is a statutory liability with an officer personally exposed, not a trade payable.
Suppliers. Stretching 15 days to 45 days damages the very relationships the firm needs in September, when component supply is tightest; suppliers respond by demanding cash, cutting quantities, or pricing in the risk. Any cash discount lost is an extra cost.
Better answer. The underlying gap is the 108-day operating cycle: 78 days of inventory, 45 days of receivables, 15 days of payables. Fund it with a seasonal enhancement of the cash-credit limit, invoice discounting, or a supplier agreement negotiated openly - for example 30 days in exchange for a small early-payment discount. Delaying statutory dues is not working capital management; it is borrowing at a penalty rate from a creditor who cannot be negotiated with.