This article first appeared in Corporate, The Edge Malaysia Weekly, on April 18 - 24, 2016.

ALARM bells sounded when it was announced that the government’s conditional RM1.5 billion soft loan to Proton would mostly go towards paying Proton Holdings Bhd’s vendors. It points to a liquidity crisis at the heavily geared company that is grappling with a sharp decline in sales.

Since Proton isn’t listed anymore, the latest financials available are for the financial year ended March 31, 2015 (FY2015) — and the numbers are not promising.

The national car maker posted a net loss of RM634.3 million for the year, a 40% increase in losses from the previous year. Meanwhile, revenue contracted by 18.6%, from RM7.16 billion to RM5.83 billion.

The poor performance can be traced to the 20.5% decline in Proton’s sales from FY2014 to FY2015, to 110,731 units.

For FY2016, industry estimates are that Proton’s sales may contract by another 15% to 93,723, which will put even more stress on the company.

As at end-FY2015, Proton’s net gearing had risen to 53%, from 30% the year before. The group’s total debts stood at RM1.71 billion while it only had RM476 million of cash and bank deposits in hand. In fact, DRB-Hicom Bhd had to advance Proton RM400 million during the year to enable the latter to meet its debt obligations.

Against this backdrop, Proton suffered from a negative operating cash flow of RM263.5 million in FY2015 compared with a positive operating cash flow of RM201.8 million in FY2014.

Perhaps the most alarming figure in Proton’s financials is the sharp rise — by 72.8% — in finished goods in its inventories to a record high of RM1.072 billion in FY2015. With Proton’s sales on the decline, rising inventories are a big concern, especially since cars depreciate quickly. A common rule of thumb in the industry is that stock has to be sold within three months.

Note that virtually all of Proton’s finished goods are valued at cost in its books. With sales falling 15% in FY2016, the group’s finished goods in its inventories might see heavy write-downs.

Overall, Proton’s inventories rose 22% to RM1.647 billion in FY2015. That makes up nearly 25% of the group’s total assets. In contrast, inventories only made up 19.6% of total assets in FY2014. When DRB-Hicom first took over Proton, inventories made up 12.6% of total assets.

Against this backdrop, Proton’s payables have risen 30.8% to a record high of RM2.26 billion. It would appear that even back in March 2015, Proton was having trouble selling its inventories to pay its vendors.

Note that Proton has some RM889.8 million in receivables as well, but that is only 39% of its payables. On top of that, RM176 million worth of receivables are for grants due from the government that Proton has not been able to collect since 2012. Stripping out the grants receivable, Proton’s RM713.7 million in receivables makes up only 31.6% of payables.

Combining Proton’s inventories with receivables (less grants) gives a sum of RM2.36 billion, barely covering the group’s payables. Keep in mind that this is on the generous assumption that the inventories can be sold at book value (cost of production) without incurring any additional distribution costs.

In a nutshell, the soft loan is only a stopgap measure for Proton. The group will need much more drastic action to turn its numbers around. 

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