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“India Corporate Finance” – Blog “The week that was” - Blog |
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What is the
ideal tenor of a WCTL? Working
Capital means money required to meet day-to-day business need. Examples are
money required to maintain inventory, fund credit extended to customers, etc.
It is short term in nature. A major portion of the working
capital is funded by other short term sources like credit from suppliers
(sundry creditors) and short term working capital
borrowings. Assuming
that a business is making healthy profits, these profits (internal accruals)
are adequate to fund working capital needs, as
the business grows. There will be no need for raising a Working Capital
Term Loan (WCTL). When an
enterprise is making losses or when it employs the working capital to fund
capital expenditure (CAPEX) or major expansion plans (which is wrong practice
and not treated kindly by banks), the organization starts feeling the cash
crunch and this will be reflected in the distortion of short term financial
parameters like Current Ration less than 1.0, negative net working capital,
maximum permissible bank finance (MPBF) less than working capital limits
already enjoyed, etc. In this
scenario, the organization will have to strengthen its working capital
position with long term funds. These long term funds may be in the form of fresh equity capital
infusion, bonds/ debentures and working capital term loan. Banks are
generally loath to extend WCTL as they consider such scenario a lending risk.
Even when banks are willing to extend WCTL, they generally offer a
repayment period of two to three years and not a term of say, six to seven
years. This brings us to the main subject of discussion here. The CMA
Data format requires to classify the repayment
obligations maturing next year as current liabilities. When an
organization raises a WCTL with a tenor of two to three years, 50% or 33.33%
of the supposedly long term arrangement to shore up working capital, again
gets classified as short term, resulting in no significant improvement in
current ratio and other parameters. This means that we are back to
square one. I have faced
this paradox in a few situations and Ace had
to arrange tailor made, really long term funds with a repayment period of
five to seven years, to strengthen the working capital position. Having
faced this painful dilemma, I thought I should share this with others. |
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