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Is This First Resources 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 palm oil producer First Resources Ltd (SGX: EB5) 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 First DIO

Source: First Resources’ 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 First DSO

Source: First Resources’ 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 First DPO

Source: First Resources’ 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 First Resources a cash conversion cycle of 54 days in 2014 (61 + 18 – 25 = 54).

In the case of First Resources, the company maintained a DIO of 61 days. This was the main contributor to the number of days found in the cash conversion cycle.

In all, First Resources’ cash conversion cycle of 54 days would mean that its business would require working capital to finance. The oil palm refining outfit has a less-than-stellar cash to debt ratio, therefore the evolution of the firm’s balance sheet may be worth watching 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.