MSME Term Loan: Thin DSCR and Stretched Working Capital Cycle
Greenfield Components, a MSME auto-component maker, seeks a ₹7.50 crore term loan for a ₹10 crore expansion. Promoter contribution is ₹2.50 crore. The CMA data show first-year EBITDA of ₹2.10 crore, depreciation ₹0.45 crore, interest ₹0.85 crore, tax ₹0.20 crore and term-loan repayment ₹1.00 crore. Working capital cycle is inventory 120 days, receivables 90 days and payables 45 days. Peak working-capital gap is ₹3.10 crore; the bank requires 20% margin. Collateral is a factory valued at ₹4.00 crore with a 50% margin. The borrower’s existing CC limit is fully utilised, and GST returns show sales growth of 18% but receivable days have risen from 70 to 90. The branch recommends sanction because DSCR is 'near 1'. Credit committee wants a judgement on viability, structure and conditions.
1. Calculate DSCR and the working-capital cycle. Is a DSCR near 1 acceptable for this greenfield MSME? Show the cash-flow stress.
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DSCR = (EBITDA − tax) / (interest + principal repayment) = (2.10 − 0.20) / (0.85 + 1.00) = 1.90 / 1.85 = 1.027. The cash surplus over debt service is only 0.05 crore, i.e. ₹5 lakh. A 3% fall in EBITDA reduces EBITDA by about ₹6.3 lakh and pushes DSCR below 1.0. That is not an acceptable cushion for a greenfield project; most banks expect at least 1.25–1.50, and a new unit should be higher because ramp-up risk is real.
Working-capital cycle = inventory 120 + receivables 90 − payables 45 = 165 days. If ₹3.10 crore is the peak gap to be financed, 20% margin = ₹0.62 crore and bank finance = ₹2.48 crore. If the ₹3.10 crore is already after margin, bank finance would be lower, so the branch must clarify the definition.
Collateral also weakens the case: a ₹4.00 crore factory at a 50% margin gives ₹2.00 crore of realisable cover against a ₹7.50 crore term loan. The branch is relying on security and growth, not on debt-service capacity.
2. Recommend the loan structure and sanction conditions. What would you change before approval?
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The loan should not be approved on the requested structure. Reduce the term loan to a size that gives DSCR of at least 1.25 on base-case EBITDA and at least 1.10 on a stress case with 10% lower sales and 15 more receivable days. Extend tenor or add a moratorium so that principal repayment starts after stabilisation, and require additional promoter contribution rather than financing the entire gap.
For working capital, sanction a limit based on the 165-day cycle and a 20% margin, but build in a staged enhancement tied to receivable reduction. Conditions should include:
- escrow of major customer receivables and a receivables-monitoring covenant;
- DSRA of at least one quarter’s interest and principal;
- fresh promoter infusion before first disbursement;
- DSCR covenant of 1.25, tested half-yearly;
- restriction on dividends or related-party payments until DSCR is met;
- quarterly stock and receivable statements, with a trigger to reduce limits if receivable days exceed 90.
The branch should also obtain a fresh valuation and confirm that the factory is marketable. If the promoter will not inject more equity, decline or sharply reduce the term loan.