Two defensible answers, and they are more than a third of a turn apart. The test everybody quotes is asked of a balance larger than the amount everybody reclassifies.
A programme that extends payment terms from 49 to 90 days for the suppliers behind 60 per cent of purchases releases 66,049,315.07 of cash. Whether that release is a working-capital improvement or a borrowing depends on how the reclassification test is applied — and the two readings differ by 0.3740 of a turn of leverage.
Worked in full in Treasury Management by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The buyer extends terms. The bank pays the supplier early — on day 10 — at a rate priced on the buyer's credit, and the buyer pays the bank on day 90. Two different amounts are outstanding at any moment, and the distinction is the whole argument.
| What it is | Amount | |
|---|---|---|
| Annual purchases on the programme | 60 per cent of cost of goods sold | 588,000,000.00 |
| Payables outstanding at any time | 90 days of that flow — what the buyer owes | 144,986,301.37 |
| Amount the bank funds at any time | 80 days — day 10 to day 90 | 128,876,712.33 |
| Cash released by the extension | 41 days gained on the programme suppliers | 66,049,315.07 |
An auditor, a lender or an outside analyst asks three questions. Who does the buyer owe — the supplier who delivered the goods, or a bank that has bought the invoice and holds the buyer's irrevocable undertaking? Have the terms been extended beyond what is ordinary for the trade? Does the bank have recourse to the buyer regardless of any dispute with the supplier?
All three are asked of the amount owed to a bank — which is the 128,876,712.33 the bank funds, not the 66,049,315.07 by which terms moved. That is why the answer comes in two readings, and the book prints both.
| Reading | Added to covenant net debt | Leverage | Against 3.0000× |
|---|---|---|---|
| Extension — the 41 days with the commercial effect of a borrowing | 66,049,315.07 | 2.7622× | 0.2378 turns of headroom |
| Balance — the amount the bank holds, which is what the test asks about | 128,876,712.33 | 3.1362× | breached |
On the balance reading the covenant is breached at today's EBITDA: the level at which 3.0000× would be met is 175,625,570.78, which is above the 168,000,000.00 the company earns. The programme does not bring a bad year within reach of the drawstop; on that reading it removes the facility on the day an auditor re-reads the caption, whatever revenue does. While the release is still held as accessible cash rather than spent, the extension reading leaves leverage at 2.3690× and the balance reading gives 2.7430×.
The programme is sold to suppliers on a saving, and the saving is real — against the new terms. On the programme the supplier pays 4.20 per cent for 80 days on 588,000,000.00 of flow, which is 5,412,821.92 a year. Funding the same 80 days on its own line at 8.50 per cent costs 10,954,520.55. The difference is 5,541,698.63.
| Baseline | Days the supplier funds | Cost a year | Against the programme |
|---|---|---|---|
| On the programme, at 4.20 per cent | 80 | 5,412,821.92 | — |
| Its own funding on the new 90-day terms | 80 | 10,954,520.55 | saves 5,541,698.63 |
| Its own funding on the terms it actually has today | 39 | 5,340,328.77 | costs 72,493.15 |
Measured against the 49-day terms the supplier has today, the programme costs it 72,493.15 a year rather than saving it anything. The 5,541,698.63 is the saving given the extension the programme itself imposes. Both figures are true; only one of them is on the slide. The honest sale is of the 41 days of the buyer's credit the supplier now funds at 4.20 per cent rather than at its own rate.
The programme is uncommitted. A bank can stop buying receivables in a bad quarter, and 66,049,315.07 of liquidity leaves at the same moment a covenant-conditional revolver does. Two conditional sources, correlated with each other: on this company, headroom over the minimum without both is -38,645,596.23.
Before signing, write down which amount the reclassification test would be applied to, and compute leverage on both. A programme that improves the cash conversion cycle by 24.60 days and might add 0.3932 turns of leverage — or breach the covenant outright — is not a working-capital tool. It is a financing decision, and it belongs in front of the same people.
It depends which amount the reclassification test is applied to. Reclassify only the extension (66,049,315.07) and leverage goes to 2.7622×; reclassify the balance the bank actually holds (128,876,712.33), which is what the test asks about, and it goes to 3.1362× — a breach at today's EBITDA.
Days gained times cost of goods sold per day times the share of purchases on the programme: 41 × 2,684,931.51 × 60 per cent = 66,049,315.07.
Against the extended terms, yes: 5,541,698.63 a year. Against the terms the supplier has today, no — it costs 72,493.15 a year, because the 80 days it funds on the programme are longer than the 39 days it funds now.
This article is one calculation from Treasury Management. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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