A Tailoring Unit's Working-Capital Choice
A six-worker tailoring unit in Belagavi gets an export order: 3,000 school uniforms at Rs 200 each, total Rs 6,00,000. Material and wages will cost Rs 4,80,000; the buyer pays 90 days after delivery. The owner needs Rs 2,00,000 now for 90 days. A bank offers 11% per annum; a microfinance institution offers 24% per annum; a friend offers Rs 2,00,000 for a flat Rs 15,000 but wants it back in 60 days. The unit has Rs 20,000 cash and no collateral except sewing machines worth Rs 1,50,000. If the buyer delays payment, the owner risks default. The owner has no written contract with the buyer, only a phone order and a WhatsApp message listing the quantity and rate. GST on the order is paid by the buyer.
1. Calculate the interest cost of the bank loan and the microfinance loan for 90 days at simple interest. Show your working.
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Bank: Rs 2,00,000 × 11/100 × 90/365 = Rs 5,424.66, about Rs 5,425. Microfinance: Rs 2,00,000 × 24/100 × 90/365 = Rs 11,835.62, about Rs 11,836. The difference is about Rs 6,411 for the same 90 days. The friend's offer is Rs 15,000 flat for 60 days, which is more expensive in money terms and also too short: the buyer pays after 90 days, so the friend's deadline falls 30 days before cash arrives. A comparison must therefore use the same loan period; on that basis the bank is the cheapest, the microfinance loan is about twice as costly, and the friend's loan is costly and mismatched.
2. Which option should the owner choose? Consider profit, collateral and risk, not only the interest rate.
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The order leaves Rs 1,20,000 before interest. With the bank loan, profit is about Rs 1,14,575; with microfinance, about Rs 1,08,164; both are positive. The bank is cheapest but may demand collateral; the sewing machines worth Rs 1,50,000 could be offered, though the owner should check whether a collateral-free scheme applies. The microfinance loan is faster and needs no collateral, but it halves the margin and imposes weekly repayments that may not match the buyer's 90-day payment. The friend's loan is the riskiest because it falls due before the buyer pays. A prudent choice is the bank loan, with a written request for a 30-day buffer and a cash reserve.
3. The buyer has a record of paying 20 days late. How should this change the decision?
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A 20-day delay pushes the cash cycle to about 110 days, so the loan period must be extended or a buffer arranged. Bank interest for 110 days would be about Rs 6,630, still far below the microfinance cost, but the friend's 60-day deadline becomes impossible. The owner should negotiate either an advance of 20-30% from the buyer or a letter of credit, and should keep at least Rs 20,000 of the existing cash for wages. If the buyer refuses, the owner should treat the order as riskier and either reduce the order size or use the microfinance loan only for the portion not covered by the bank. The decision changes in risk management, not in the ranking of interest costs.