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Debt question on case interview response

Hey,

I received a question as part of a case for a biscuit manufacturer which was struggling with profitability 

"Is there too much debt on the balance sheet? What short and long-term levers can we use to reduce the debt?

My response was as follows:

We can check the DSCR, ICR and Debt:Equity to check how leveraged the balance sheet is. Ratio below 1.2 for DSCR would indicate that we are highly leveraged. Obv taking into account that the PE investor may have loaded on debt to expand the business would need to be taken into consideration.

In terms of levers, the following were suggested:

Short term:

Sale of collateral (including aged inventory)

Divestment

Medium-long-term:

Strategic investor to increase equity 

Refinance

Any suggestions to improve this answer? Obv one would have been to increase profitability to improve cashflow but the main prompt was that the business is struggling with profitability. 

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Top answer
Maikol
Coach
on Oct 24, 2022
BCG Project Leader | Former Bain, AlixPartner, and PE | INSEAD MBA | GMAT 780

It is always more common to receive questions on debt restructuring because there are a lot of consulting firms jumping on turnaround and restructuring services given the macroeconomic situation ahead.

However, your answer is quite weak. 
First debt-service-coverage-ratio (DSCR) is a good KPI but it is useful only in the short term. It may be that 

  • the company doesn't have an issue with DSCR but still has too much debt; therefore you have to take into account other metrics (D/E, Net Financial Position / EBITDA)
  • over the short term debt repayment is not significant but over the long term it is
  • the company generates profits but does not generate cash

The last point is the most important one. 
Cash generation is the most important thing to take into account. Profits can be affected by one-off items and non-cash items, cash can be affected bu one-off items (and you should mention it) but gives you an indication of the sustainability of debt.

As a consequence, there are several other things you have to consider: reduce net working capital and reduce CapEx.

You also have to take into account the future prospects of the company. Is the company able to generate more cash?

My suggestion is to reconsider your answer and craft a compelling and MECE structure that integrates my suggestions.
If you need help, feel free to schedule a call.

Ian
Coach
on Oct 24, 2022
#1 BCG coach | MBB | Tier 2 | Digital, Tech, Platinion | 100% personal success rate (8/8) | 95% candidate success rate

Hi there,

I agree with Maikol.

This might be a “passing” answer, but you've just listed a bunch of ideas instead of coming up with a structured approach! Ideally, we want to stay away from “time” as buckets (short vs medium). 

Rather, think about it from a cashflows perspective (rev/cost), a debt size/cash perspective, and a payments perspective (interest, length of debt, etc.)

Anonymous A
on Oct 25, 2022
Thanks for the response, Ian. In terms of the structuring approach, the question was to brainstorm ST and LT levers (updated in question) now. I agree with your point on cash.
Udayan
Coach
on Oct 24, 2022
Top rated Case & PEI coach/Multiple real offers/McKinsey EM in New York /12 years recruiting experience

Looks good to me. You can talk about alternative ways to raise cash such as improve net margins so higher cash flows which can be used to service debt or you can talk about substituting high interest debt for lower interest debt etc.

Anonymous
on Oct 24, 2022

Hi,

I would be very surprised if you encounter such a question during actual interviews (financial vs. strategic case).  

Best regards,

Jorn

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