A manufacturing borrower’s stock statement shows Rs 9 crore of inventory: Rs 4 crore of raw materials, Rs 2.5 crore of work-in-progress and Rs 2.5 crore of finished goods. The drawing power is calculated. The margin is applied. The facility is utilised against the inventory.
The lender’s assumption: the inventory can be converted to cash. Raw materials will be consumed in production. Work-in-progress will be completed. Finished goods will be sold. The cash from the sale will service the facility. The inventory is security because it has realisable value.
The Inventory Funding Test challenges this assumption by examining whether the inventory actually possesses the characteristics that make it realisable: does it exist, is it in saleable condition, is it valued at a realisable price, is it moving through the production and sales cycle at the speed the borrower’s working capital model assumes, and would a buyer actually pay for it in a distress scenario?
Where inventory value disappears
Obsolescence concealed in the aggregate. The Rs 4 crore of raw materials includes Rs 80 lakh of a specific chemical compound that the borrower purchased 14 months ago for a product line that was subsequently discontinued. The compound cannot be used in any current product. It cannot be returned to the supplier (the return window closed 10 months ago). It cannot be sold to another manufacturer (the compound is formulation-specific). The stock statement carries it at purchase cost. Its realisable value is the scrap rate, approximately Rs 4 lakh.
The borrower has not written it down because the write-down would reduce reported profit by Rs 76 lakh, which would reduce the EBITDA, which would tighten the DSCR, which would trigger a covenant discussion with the lender. The inventory sits in the godown, on the books and in the stock statement, supporting a drawing power that it cannot actually back.
Condition deterioration not captured in the records. The Rs 2.5 crore of finished goods includes Rs 40 lakh of products stored in a section of the warehouse with a leaking roof. The products are moisture-sensitive. The packaging is water-stained. The products are technically present and technically counted in the stock verification. They are not saleable to any customer who inspects them.
The stock statement does not have a column for condition. It has columns for quantity and value. The condition is visible only to the person who walks through the godown and looks at the inventory, not to the person who reconciles the statement to the ledger.
Slow-moving stock masquerading as current. The Rs 2.5 crore of work-in-progress includes Rs 60 lakh of partially completed orders for a customer who cancelled the order three months ago. The WIP cannot be completed and sold to another customer because it is customer-specific (custom dimensions, custom specifications, custom packaging). The borrower has not reversed the WIP because the customer has not formally confirmed the cancellation in writing, and the borrower hopes the customer will reinstate.
The stock statement shows Rs 60 lakh of WIP. The economic value is the scrap value of the partially processed raw materials, approximately Rs 15 lakh.
Valuation above realisable value. The raw materials were purchased at Rs 200 per kg. The current market price is Rs 160 per kg. The stock statement carries the inventory at Rs 200 per kg (cost). If the borrower were to liquidate, the inventory would realise Rs 160 per kg, which is 20% below the stated value. On Rs 4 crore of raw materials, the overvaluation is Rs 80 lakh.
Indian Accounting Standards require inventory to be carried at the lower of cost and net realisable value. Many mid-market borrowers do not perform the NRV assessment rigorously, or perform it only at year-end, leaving the stock statements submitted to the lender during the year at historical cost regardless of current market conditions.
The physical verification methodology
Rishabh Koli conducts the physical verification at every storage location. The verification is not a sample. It is a complete count of every material inventory category, because the discrepancies that matter are concentrated in specific items, not distributed randomly across the inventory.
Count. Every material item counted, recorded and photographed. The count is reconciled to the stock statement and to the perpetual inventory system (Tally, ERP or manual records). Discrepancies (items in the books but not in the godown, items in the godown but not in the books) are quantified by item.
Condition assessment. Every material item assessed for saleability: is the packaging intact? Is the product within its shelf life? Has it been stored in conditions appropriate to its requirements (temperature, humidity, light exposure)? Is there visible damage, contamination or degradation? Items that exist physically but cannot be sold are classified separately: their book value supports the drawing power, but their realisable value does not.
Ageing analysis. Every material item aged from the date of receipt or production. Items older than the borrower’s normal sales cycle (determined from the historical turnover rate) are classified as slow-moving. Items older than twice the normal cycle are classified as potentially obsolete. Items with no movement in six months or more are classified as dead stock.
Valuation test. For raw materials, the carrying cost is compared to the current market price. For finished goods, the carrying cost is compared to the expected selling price minus the cost to complete and sell. Items whose carrying cost exceeds the NRV are flagged, and the drawing power adjustment is calculated on the lower value.
Ownership verification. Items physically present in the borrower’s premises are verified for ownership: does the borrower own the inventory, or is it consignment stock (owned by a supplier, stored at the borrower’s premises for convenience)? Is it goods received for job processing (owned by a customer, at the borrower’s premises for processing only)? Is it stock belonging to a group entity stored in the same warehouse?
Consignment stock and third-party-owned goods are excluded from the drawing power calculation. In one verification, Rs 1.1 crore of inventory physically present in the borrower’s godown was consignment stock from two suppliers. The stock statement included it. The drawing power was calculated on it. The borrower did not own it.
Drawing power recalculation
The verified inventory (existing, owned, saleable, correctly valued) replaces the reported inventory in the drawing power calculation. The components that are excluded: items not physically present, items physically present but not saleable (damaged, expired, obsolete), items not owned by the borrower (consignment, job work, group entity stock), and the valuation adjustment for items carried above NRV.
The recalculated drawing power, based on verified inventory with realisable value, is compared to the reported drawing power. The difference is the excess drawing: the amount by which the facility utilisation exceeds the security that the inventory actually provides.
What the lender receives
A physical stock verification report covering: item-level count versus book balance with discrepancy analysis, condition assessment with saleability classification, ageing analysis with slow-moving and obsolete identification, valuation test with NRV comparison, ownership verification with consignment and third-party exclusions, and recalculated drawing power based on verified, owned, saleable, correctly valued inventory.
The report answers the question the stock statement cannot: not what inventory the borrower claims to have, but what inventory the borrower actually has that can actually be converted to cash.