Rourkela E-Mobility: Working Capital and the Discount Trap
Rourkela E-Mobility assembles 60 e-rickshaws a month. Each vehicle sells for ₹62,000 and uses raw material costing ₹36,000, direct wages of ₹8,000 and overheads of ₹6,000. The firm buys on 20 days' supplier credit and holds 30 days of raw material in stock. Assembly takes 10 days, finished vehicles wait 15 days before dispatch, and dealers pay 45 days after dispatch. Sales and production are even through the year, costs are incurred evenly, and the firm holds no cash balance of its own. A bank has sanctioned a cash credit limit at 11% a year against a margin. The accountant proposes stretching supplier credit to 40 days by giving up the 2% cash discount that suppliers offer for payment within 20 days. Separately, a friend has offered ₹20 lakh for a 20% equity stake, the proceeds to be used to reduce the cash credit.
1. Compute the operating cycle in days and the working capital requirement, showing the working.
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Operating cycle:
- Raw material holding: 30 days
- Work-in-progress (assembly): 10 days
- Finished goods before dispatch: 15 days
- Debtors after dispatch: 45 days
- Gross operating cycle = 30 + 10 + 15 + 45 = 100 days
- Less supplier credit: 20 days
- Net operating cycle = 80 days
Daily cost: 60 vehicles × ₹50,000 (36,000 + 8,000 + 6,000) = ₹30,00,000 a month ÷ 30 = ₹1,00,000 a day.
Working capital requirement = 80 days × ₹1,00,000 = ₹80,00,000.
Two cautions. First, the debtors figure is deliberately taken at cost; if receivables were valued at the selling price of ₹62,000, the requirement would rise by 45 days × 60 × ₹12,000 ÷ 30 = ₹10,80,000, but banks finance debtors at cost, so ₹80 lakh is the defensible figure. Second, no cash buffer is included, so the ₹80 lakh is a minimum, not a comfortable level. The bank will also insist on a margin, meaning the firm must find part of this from long-term funds.
2. Evaluate the accountant's proposal to stretch supplier credit to 40 days. Show calculations.
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Saving from the extra 20 days of credit: 20 days × ₹1,00,000 a day = ₹20,00,000 of working capital released. At 11%, the interest saved = 20,00,000 × 0.11 = ₹2,20,000 a year.
Cost of losing the cash discount: monthly raw material purchase = 60 × ₹36,000 = ₹21,60,000. Discount at 2% = ₹43,200 a month, or 43,200 × 12 = ₹5,18,400 a year.
The discount costs more than twice what the extra credit saves, so the proposal should be rejected: net annual loss ≈ ₹5,18,400 − ₹2,20,000 = ₹2,98,400.
The general rule: compare the interest cost of the credit period gained with the discount lost. Here the implicit annual cost of the discount is about 2/98 × 365/20 ≈ 37% - far above the 11% bank rate, so paying early with borrowed money is cheaper. A second argument reinforces the point: suppliers who are squeezed may respond by lowering quality or priority in a shortage, which matters more than the rupee arithmetic when raw material quality drives e-rickshaw safety.
3. Advise how the ₹80 lakh should be split between the friend's equity and the cash credit, using the idea of trading on equity.
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The friend's ₹20 lakh for 20% values the whole firm at ₹1 crore, so the equity is expensive.
Earnings test: annual sales = 60 × 62,000 × 12 = ₹4,46,40,000; annual cost = 60 × 50,000 × 12 = ₹3,60,00,000; contribution before interest, administration and tax ≈ ₹86,40,000. Interest on the full ₹80 lakh at 11% is ₹8,80,000 - about 10% of the earnings before interest. In other words, every rupee borrowed earns roughly ten times its interest cost, so debt is very much cheaper than giving away 20% of the equity.
Recommendation: fund the requirement mainly from the cash credit - say ₹60–65 lakh - and keep the friend's offer in reserve, or negotiate a smaller stake for the money. Trading on equity works in the firm's favour because the return on capital employed comfortably exceeds the 11% cost of debt.
But do not borrow the whole ₹80 lakh. The bank will demand a margin of about 20–25%, and fixed interest must be paid even in a bad month. Keeping ₹15–20 lakh of long-term funds (owner's capital or a small equity infusion) as margin reduces the risk of default, which is the other half of the trading-on-equity decision: favourable when earnings are stable, dangerous when they are not.