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Is SembCorp Marine Ltd Gushing with Cash?

“Cash, though, is to a business as oxygen is to an individual: never thought about when it is present, the only thing in mind when it is absent. When bills come due, only cash is legal tender. Don’t leave home without it.”

— Warren Buffett

As we search for positive signs in a new company, the cash flowing through the firm may be one thing worth looking up. In particular, the cash conversion cycle of a company may be of interest to the Foolish investor.

Turning goods into cash

Simply said, the cash conversion cycle is the number of days it takes for a company to 1) convert cash in the bank into inventory, 2) sell that inventory, and 3) receive the cash from the sale. The shorter the cycle goes, the better.

To learn how to calculate the cash conversion cycle, go here.

Let’s run SembCorp Marine Ltd (SGX: S51), a leading player in the offshore and marine sector, through this calculation today.

We start with the Days Inventory Outstanding (DIO) metric. DIO is the number of days that it takes for a company to sell its entire inventory. Generally speaking, the lower the number of days, the more effective the company’s inventory management is.

Below is a summary table with all the relevant figures:

2014 SembCorp Marine DIO

Source: SembCorp Marine’ earnings report

Next up, we have the Days Sales Outstanding (DSO) figure. DSO represents the amount of time it takes the company, on average, to receive money after it has sold a good or service. Having a lower DSO usually indicates that a company is good at credit management.

2014 SembCorp Marine DSO

Source: SembCorp Marine’ earnings report

Finally, we come to Days Payable Outstanding (DPO), which is the number of days it takes a company to pay its suppliers after their products have arrived. In general, having a longer payment term is better for the company.

2014 SembCorp Marine DPO

Source: SembCorp Marine’ earnings report

Pulling it together

The cash conversion cycle can now be put together by adding the DIO with DSO and subtracting the DPO. Doing so would give SembCorp Marine a cash conversion cycle of 116 days in 2014 (220 + 29 – 133 = 116).

In the case of SembCorp Marine, its manufacturing process may require long lead-times. As such, the firm needed to sustain, on average, an estimated 220 days in inventory and work-in-progress in 2014. The good news though, is that SembCorp Marine appears to keep a fairly tight rein on its customers’ payment terms with an average of just 29 days.

In all, the cash conversion cycle of 133 days would mean that Sembcorp Marine’s business would require working capital to finance. The offshore and marine engineering outfit does not have the strongest balance sheet around, therefore its borrowings may be an area to watch going forward.

Over time, tracking the changes in a company’s cash conversion cycle may help the Foolish investor understand the business changes that the company makes and whether those changes helps bring in the cash faster.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.