This is Vikaas here, Investment Advisor and Founder of www.jaagrav.com. Today I am going to talk about how messing with working capital in a business leads to disastrous outcomes.
Last week, while I was talking to one of my banker friends, he brought about a very interesting point about how so many companies have got into distress and that the entire banking system is beset with non-performing assets (‘NPAs’), now being recognized by banks, thanks to the government and the new bankruptcy reform, Insolvency & Bankruptcy Code (‘IBC’) introduced some time back.
While the erstwhile promoters who are in the process or have got stripped off their assets have blamed oscillating regulations, lack of transparency, business environment, one thing which got clearly missed out was that most of them had got nailed because of their (mis)adventure to fund their working capital.
With cost of borrowing being lowest on short-term maturities, these companies raised short-term debt in order to fund corporate assets or take on long-term gestation projects. This arrangement “borrowing short to invest long” worked out well, when the going was good, i.e. when there was surging demand and the credit cycle was buoyant. The bankers felt that that there is only one way the trajectory will move, i.e. ‘UP’.
This explains why power, infrastructure and steel are the largest contributors to the banking NPA mess, since these sectors followed this funding principle to the T, considering that they had burgeoning long-term capital expenditure requirements, some or ‘substantial’ portion of which got funded through short-term capital.
However, this mis-match between long-term assets and short-term funding eventually came to light when demand tapered and credit markets started questioning this practice, whereby long-term assets could no longer be liquidated to fund short-term liability. The promoters didn’t fathom that credit markets have propensity to shut-off, especially during down-cycles.
This was just the beginning of the end; messing with working capital is like having the veins being cut, eventually dissipating the entire nervous system and the body.
As Howard Marks has very succinctly put the following:
Prosperity leads to expanded lending, which leads to unwise lending, which produces large losses, which makes lenders stop lending, which ends prosperity, and on and on.
Please note that these are my personal views. Request you to conduct your own independent research or consult your financial advisor before investing.
Hope you enjoyed listening to this!!
For more interesting topics, you may check out my website, www.jaagrav.com. If you want to reach out to me, you may email me at vikas@jaagrav.com
Thanks!