How Banks Assess a Working Capital Request

Every bank phrases it differently and every credit policy lists it in its own words, but the assessment runs in the same order wherever it is done well: the need before the request, the numbers underneath before the story on top, and the structure last, because the structure is the answer to everything before it. Each step below links to the page on this site that works it in full.

The first question is what the money will fund, and the answer has to be one the numbers can confirm: stock for a season, receivables from customers who pay slowly, growth the business has already achieved, or a gap that stopped closing and nobody said so. The second is how much money the business's own terms tie up. Debtor days, stock days and creditor days make the cash conversion cycle, and the cycle applied to the sales gives the working capital the business carries at its present size.

That number is worked out before the request is read, and it is read at the heaviest month of the year, not at the balance-sheet date: a seasonal business can look comfortable at year-end and run out of facility in its busiest quarter. Where the facility will be tied to receivables or stock, the limit is set by a borrowing base instead — eligible assets times an advance rate — which does the sizing as the business moves. The current ratio, which most checklists start with, is leaned on least: it describes one date in the year, and a working capital request is about the other three hundred and sixty-four.

Then the desk asks what the request is actually funding. Is the growth real, or is it being bought with working capital — receivables running ahead of sales, stock building faster than it sells? Is reported profit converting to operating cash, or being absorbed somewhere between the invoice and the bank account? And are suppliers quietly carrying the gap, so that the request is refinancing creditors who have stopped waiting? Those are the Three Diagnostics, and the calculator runs them on twelve numbers from two years of accounts.

The answer divides requests into two kinds that look identical on the form. One funds a business that has grown and needs a larger facility to carry its larger cycle; the other funds a cycle that has lengthened, and would pay for the problem rather than fix it. The working capital case study works that pair through two published files that reach opposite answers.

A working capital facility is built for a balance that returns to zero. So the desk reads the existing line's history before it reads the new limit: whether it clears each year, and where the balance sits at the trough of the cycle. What never clears is permanent working capital — money the business now needs all year round — and it belongs in a term loan repaid from cash flow, not in a facility that revolves and is renewed every twelve months.

Most requests are a mixture, and the useful answer separates the two rather than approving or declining the whole. Temporary or permanent working capital sets out the evidence that tells them apart and the four findings it leads to.

A working capital facility is still debt, and it is repaid in cash. The desk takes operating cash flow after capital expenditure, tax and what the owners take out, sets it against the interest and principal due with the new facility included, and runs a bad year — slower sales, a thinner margin, customers paying later — to see whether the answer survives. The cash flow analysis reads the history; the forecast is tested the way banks test borrower forecasts, starting with how accurate this management's last forecast was.

Only now is the product chosen, and the rule is that the facility should be repaid by the same thing the money funds. An overdraft for day-to-day swings; a revolving credit facility for a larger cycle that clears; a trade loan for one identifiable shipment repaid when it sells; invoice finance where the receivables ledger itself is the security; a term loan for the part that never clears. Security and covenants follow from the same reading: a clean-down where the need is seasonal, reporting and headroom where the diagnostics were close, and a tighter structure rather than a decline where management's record is thin.

The assessment does not end at approval. Utilisation is watched against the cycle the facility was sized on, the clean-down is either met or explained, and the monthly reporting is set against the forecast. The first sign that a seasonal line has become permanent money is usually a trough that sits a little higher each year — which is why the next request is often decided by what the last one did. The machinery is in how banks manage credit risk, and the borrower meets it at the annual review.

Most credit training starts with the 5 Cs of credit — character, capacity, capital, collateral and conditions — and all five are in the sequence above, just not in that order. Capacity is steps four and six: whether profit becomes cash, and whether the cash carries the debt. Capital — how much of the business is the owners' own money — sits in step six beside the debt it would carry; collateral is step seven, the structure and the way back out. Conditions — the sector and the economy the business trades in — set the size of every number in step two. Character runs through all of it, and a desk reads it as a record rather than an impression: how banks assess management quality sets out what that record is made of.

The 5 Cs make sure nothing is left out. The order above decides what is looked at first — and on a working capital request, that is the cycle.