Working Capital, Cash Conversion and Covenant Headroom in FMCG
You are reviewing the FY24 results of a Karachi-based FMCG company for a lender. Revenue grew 28.6% to PKR 18.0 billion from PKR 14.0 billion, and EBITDA rose to PKR 2.70 billion from PKR 2.10 billion. Operating cash flow was only PKR 0.90 billion. Receivables increased to PKR 3.20 billion from PKR 1.90 billion; inventory to PKR 3.80 billion from PKR 2.60 billion; payables to PKR 2.40 billion from PKR 2.20 billion. Cost of goods sold was PKR 12.5 billion in FY24 and PKR 9.8 billion in FY23. Net debt is PKR 7.60 billion. The term loan requires net debt/EBITDA below 3.0x, tested quarterly. The CFO says growth is the cause and asks for a covenant waiver. Sales in the last two weeks of June were PKR 400 million to distributors with 90-day return rights; the company normally has no such rights. Gross margin on those sales is 20%.
1. Calculate the cash conversion cycle for both years and quantify the working capital drag. Why is CFO only PKR 0.90 billion when EBITDA is PKR 2.70 billion?
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FY24: DSO = 3.20/18.0 × 365 = 64.9 days; DIO = 3.80/12.5 × 365 = 111.0 days; DPO = 2.40/12.5 × 365 = 70.1 days. CCC = 64.9 + 111.0 − 70.1 = 105.8 days.
FY23: DSO = 1.90/14.0 × 365 = 49.5 days; DIO = 2.60/9.8 × 365 = 96.8 days; DPO = 2.20/9.8 × 365 = 81.9 days. CCC = 64.4 days.
The CCC lengthened by 41.4 days. The incremental cash absorbed is receivables +1.30bn, inventory +1.20bn, less payables +0.20bn = PKR 2.30bn. That is the main bridge from EBITDA to CFO: 2.70 − 2.30 = 0.40bn before tax, interest and other items, consistent with CFO of 0.90bn after adding back depreciation and other non-cash charges.
The company is funding growth through the balance sheet, not just the P&L. Payables days fell, so suppliers are not financing the expansion. The CFO's claim that growth is the sole cause is only partly true: collections and inventory efficiency have deteriorated.
2. Assess covenant headroom under the base case and under a stress case where EBITDA falls 15% and net debt rises by PKR 0.50 billion. What does the June sales treatment do to adjusted EBITDA?
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Base case: net debt/EBITDA = 7.60/2.70 = 2.81x. Maximum permitted net debt at 3.0x = PKR 8.10bn, so headroom is PKR 0.50bn, or 6.2% of EBITDA.
Stress case: EBITDA = 2.70 × 0.85 = PKR 2.295bn; net debt = PKR 8.10bn. Leverage = 8.10/2.295 = 3.53x, a clear breach. Even without the extra PKR 0.50bn debt, 7.60/2.295 = 3.31x, still above 3.0x. Headroom is therefore illusory if margins weaken.
The PKR 400m of June sales with 90-day return rights should not be recognised as revenue where returns are probable. If reversed, revenue falls by PKR 400m and EBITDA by 20% × 400 = PKR 80m. Adjusted EBITDA = PKR 2.62bn; adjusted leverage = 7.60/2.62 = 2.90x. Headroom falls to about PKR 0.26bn. The lender should also check whether the related receivables are collectible and whether the sales were pulled forward from July.
3. Recommend three actions the company can take to restore covenant headroom, and explain how each affects the lender's position.
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First, tighten credit control: reduce DSO from 65 days toward 50 days, which would release roughly PKR 0.74bn of receivables (15/365 × 18.0). This improves liquidity without adding debt. The lender should require a monthly receivables ageing report and a lockbox or assignment of proceeds.
Second, reduce inventory days from 111 toward 95 by cutting slow-moving SKUs and improving forecasting. That releases about PKR 0.55bn. The lender should verify the inventory is not obsolete and should test the borrowing base if inventory is collateral.
Third, stop the quarter-end sales with return rights unless the return risk is priced and disclosed. Reversing PKR 400m of revenue and PKR 80m of EBITDA cuts covenant headroom, but it improves earnings quality. The company should instead negotiate a covenant reset tied to an equity injection or a longer testing period, not simply request a waiver. A waiver without a cure merely transfers risk to the lender.
The lender's best package is a short waiver combined with tighter reporting, a cash sweep, and a commitment to raise equity if leverage exceeds 2.90x.