Knitwear Exporter Asks for a 58% Limit Increase While Margins Fall
Al-Karam Knitwear (Pvt) Ltd, a Faisalabad SME, exports 60% of its output to the EU and sells 40% locally. FY2024 sales were PKR 480 million, up from PKR 410 million, but the EBITDA margin fell from 11% to 9% as buyers pushed prices down and gas costs rose. The company already has a running finance (RF) limit of PKR 40 million, fully utilised, and a PKR 10 million import LC line. It now asks for RF of PKR 70 million and an LC line of PKR 30 million. Receivable days are 95 (were 70), inventory days 80 (were 62) and payable days 45. The sponsor's factory has a forced-sale value of PKR 120 million, already mortgaged for the existing facilities and a PKR 35 million term loan; a second charge over a family-owned plot (FSV PKR 45 million) is offered. Debt service coverage is 1.15x. Export receivables are in USD, local sales in PKR. The relationship manager's annual incentive depends on new limits booked.
1. Assess whether the enhancement should be recommended. Show the working-capital arithmetic and identify the two risks that matter most.
Read the worked answer
Working-capital arithmetic. The cash cycle has moved from 70 + 62 − 45 = 87 days to 95 + 80 − 45 = 130 days, a 43-day deterioration. On sales of PKR 480m, one day of cycle absorbs 480/365 = PKR 1.315m, so the stretch consumes roughly PKR 56m of additional funding. The request is +PKR 30m funded (RF 40 → 70) plus +PKR 20m of LC. It does not cover the gap, and the gap is caused by receivable and inventory quality, not by growth alone.
Why the margin matters. EBITDA has gone from PKR 45.1m (11% of 410m) to PKR 43.2m (9% of 480m): sales up 17%, EBITDA down 4%. At a 1.15x DSCR there is little buffer, and adding the RF enhancement and the term-loan instalments pushes coverage below 1.0x.
The two risks that matter
- Receivable quality. 95 days with EU buyers is unlikely to be a pure terms change; it is either buyer-side stress or a build-up of aged/disputed invoices. Ask for an ageing by buyer and confirm the credit status of the top three.
- Structural margin erosion. Gas cost and price competition from Bangladesh are permanent, not seasonal. Lending into a shrinking margin with rising leverage is refinancing risk in disguise.
Recommendation: decline the full ask, offer a sized facility (see next task).
2. Structure the facility you would actually recommend: limits, security, covenants, pricing rationale and exit triggers.
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Structure
- RF PKR 55m against hypothecation of stock and receivables at a 25% margin, with drawing power recalculated monthly; no drawing against receivables older than 90 days.
- LC line PKR 20m, for raw material only, tenor matched to the production cycle.
- Security: retain the existing first charge on the factory; take the second charge over the family plot (FSV PKR 45m) with a valuation under 12 months old, the owner's personal guarantee, and an assignment of export proceeds routed through a dedicated account at the bank.
- Covenants: DSCR ≥ 1.25x tested annually; current ratio ≥ 1.10; no dividend or sponsor drawings while the RF is outstanding; top-five buyer concentration ≤ 60%; no single receivable above 15% of the book; monthly stock and receivable statements with quarterly accounts.
- Pricing: KIBOR + 400–450 bps is defensible for a 1.15x DSCR client with a falling margin; LC commission and the FX spread on export proceeds are part of the return. Do not price at the floor to win the limit.
- Exit triggers: two consecutive quarters of EBITDA margin below 7.5%, receivable days above 110, or DSCR below 1.05x - limit reduced by 25% and no new LC until cured.
Reasoning: size the facility to the verified working-capital gap rather than to the request, and take security over the cash flow it secures - which is why proceeds are controlled through the bank.
3. The branch manager says 'book it before year-end, we can tighten conditions later.' How do you handle the incentive conflict and what do you put in writing?
Read the worked answer
The conflict. The RM is paid on new limits booked, so his recommendation is not independent advice. The credit process exists to absorb exactly this conflict - it is a reason for rigour, not a reason for silence.
What to do
- Write the assessment. Recommended and declined amounts, the PKR 56m working-capital arithmetic, the receivable ageing, buyer concentration and the conditions. A file that records why a smaller limit was recommended protects both the RM and the bank.
- Route it to the correct approval authority. Do not let the branch 'own' the decision because the year-end target is close. If management wants the full PKR 70m, the override must be recorded by an authority senior to the approving authority, with reasons, and copied to credit risk.
- Disclose the incentive in the credit note. It costs nothing and removes any later suggestion that the RM shaped the numbers.
- Do not adjust the customer's figures or the ageing to fit a target. If asked to, that is a compliance matter, not a negotiation.
What to say to the branch manager: 'I can support PKR 55m plus the LC today, on these conditions. If you want PKR 70m, the file needs the higher authority and a written rationale, and I will record that I recommended the lower figure.'
That sentence keeps the relationship, protects the customer, and preserves the record. 'Tighten later' is not a condition - it is a promise that no one will test.