Fault Lines

“A working capital loan is a loan that is taken to finance a company’s everyday operations. These loans are not used to buy long-term assets or investments and are, instead, used to provide the working capital that covers a company’s short-term operational needs.” - Investopedia

The Indian financing sector is no stranger to Working Capital Loans. Any 1st year analyst is aware of the terms “inventory”, “book debts”, and “trade payables” while assessing the “working capital gap”, “DP”, and “margin requirement” for a manufacturing or trading company. In essence, lenders are willing to finance the amount secured against stock and book debts of a company. They reduce the trade payables to arrive at the working capital and reduce a “margin” requirement akin to “promoters’ contribution” and arrive at the “DP” or Drawing Power, i.e. the amount of funding the borrower is eligible for and can secure the bank against his working capital. This offers a dual benefit

1. Banks are secured against what are believed to be “liquid” securities, being inventories and book debts which are fast moving in usual business circumstances;
2. Businesses are able to draw funds at low rates with a tax shield thus enabling them to operate at higher capacities.

So it arrives from the discussion that a business having negative working capital is not eligible for working capital funding.

1. There is no security against the working capital debt;
2. If a business is able to hold off paying its creditors (0 interest) while being able to collect faster from its debtors, then there’s no need to draw any working capital;

So far so good. This is why we see most companies having negative working capital not having any working capital loans. While one may see substantial long-term loans on their books, the short-term working capital loans are almost non-existent. Such companies are also ones with good working capital management being able to collect-first and serve-later.

 That is why it is surprising when we find the adjacent financials in one of the largest companies in the country. It is clear that the massive amount of Trade Payables easily turns the working capital of the company negative. However, the company enjoys working capital facilities of ₹ 24 from banks and others.

As per the RBI’s Master Circular dt 2 Jul 2012 on “Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances”, it is stated that,

“Banks should ensure that drawings in the working capital accounts are covered by the adequacy of current assets, since current assets are first appropriated in times of distress… A working capital borrowal account will become NPA if such irregular drawings are permitted in the account for a continuous period of 90 days even though the unit may be working or the borrower's financial position is satisfactory.”

On the face of it, our company in question maintains a Current Asset base of ₹ 167. However, of these current assets, only ₹ 46 is a part of the working capital and ₹ 32 is liquid. The bulk of the current assets are unquoted investments which may or may not be marketable in times of distress. Further, the company also has a large Current Liability base of ₹ 310 eating into the security for working capital loans. It is also seen that this inadequate working capital is not a one-time delinquency in the company but more of a behavioural pattern.

So the question arises, if the working capital loans are neither deployed nor secured by current assets, then what has been their use? And which is this company that we are talking of?

The 1st question remains unanswered.

For the 2nd question, we’ll leave you with a few hints

1. All figures quoted have been in ‘000 Cr, i.e. the working capital loans are not ₹ 24, they are ₹ 24,000,00,00,000
2. This was the 1st Indian company to cross ₹ 10 lac Cr in market cap;
3. The company has been trying to bring down its debt levels since 2019, and has resulted in some of the largest FDI inflows in the country during the COVID-19 period