Trade Credit to a Growing Distributor
Baraka Distributors applies for a KES 8 million revolving trade credit facility. Financials show: revenue KES 40 million, gross margin 22%, net profit KES 1.6 million, receivables KES 9 million, inventory KES 6 million, payables KES 5 million, and a bank overdraft of KES 3 million already in use. The owner claims 'sales are booming' and provides a single year of accounts, no audited statements, and no management accounts. A credit reference bureau report shows two late payments on a prior supplier account in the last 18 months, both cleared. The relationship manager is under pressure to hit a monthly disbursement target and recommends approval on the strength of the sales growth story.
1. Assess the creditworthiness using ratio analysis and identify the key information gaps.
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Working capital cycle:
- DSO = 9/40 × 365 = 82 days
- DIO = 6/40 × 365 = 55 days (using revenue as proxy; COGS-based ~70 days)
- DPO = 5/40 × 365 = 46 days
- Cash conversion cycle ≈ 82 + 55 − 46 = 91 days - long; cash is tied up.
Profitability & leverage:
- Net margin = 1.6/40 = 4% - thin.
- Existing overdraft KES 3m plus proposed KES 8m = KES 11m debt against KES 1.6m profit - high leverage.
- Current assets (9+6=15) vs current liabilities (5+3=8) gives a current ratio of ~1.9, but much of it is slow-moving.
Information gaps: Only one year of data, unaudited, no management accounts, no cash flow statement, no ageing of receivables. The 'booming sales' claim is unverified and could be inflating receivables quality.
Bureau: Two late payments, both cleared - a minor but non-trivial conduct flag suggesting past liquidity stress.
2. Recommend a credit decision with conditions, and explain how the relationship manager's incentive conflict should be handled.
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Recommendation - approve with strong conditions, not on the sales story:
- Reduce exposure - start at KES 4m, not KES 8m, with a review after 6 months of clean conduct.
- Secure the facility - require a debenture or assignment of receivables; the receivables book (KES 9m) can support a borrowing base.
- Borrowing-base structure - limit drawings to, say, 70% of eligible receivables under 60 days, forcing collection discipline.
- Conditions precedent - audited or at least accountant-certified accounts, monthly management accounts, receivables ageing, and a personal guarantee from the owner.
- Covenants - minimum DSCR, maximum gearing, no further borrowing without consent.
Incentive conflict: The RM's disbursement target creates a pressure to approve weak credit. This must be escalated to the credit committee, and the decision documented independently of the RM's recommendation. Incentive schemes should be reviewed so volume targets do not override credit quality - a governance control, not just a sales issue.