Is SembCorp Industries Limited 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 Industries Limited (SGX: U96), a leading player in the utilities 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 Ind DIO

Source: SembCorp Industries’ 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 Ind DSO

Source: SembCorp Industries’ earnings report

Finally, we come to the 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 a company.

2014 SembCorp Ind DPO

Source: SembCorp Industries’ 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 Industries a cash conversion cycle of 57 days in 2014 (123 + 40 – 106).

In the case of SembCorp Industries, the nature of its utilities and marine business (like power plants and rigs) may require long lead-times to develop. As such, the firm had to sustain an estimated average of 123 days in inventory and work-in-progress in 2014.

That said, the DIO for SembCorp Industries is notably lower when compared to its subsidiary, SembCorp Marine Ltd  (SGX: S51). On the whole, the cash conversion cycle for SembCorp Industries is also less than half of that of SembCorp Marine (116 days for the latter).

In all, Sembcorp Industries’ cash conversion cycle of 57 days would mean that the company’s business would require working capital to finance. The utilities and marine outfit does not have the best balance sheet around, therefore this 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.