Is Dairy Farm International Holding 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 convert cash in the bank to inventory, selling that inventory, and receiving 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 Dairy Farm International Holding Ltd (SGX: D01), a  pan-Asian retailer, 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 Dairy Farm DIO

Source: Dairy Farm’s 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 that is good at credit management.

2014 Dairy Farm DSO

Source: Dairy Farm’s 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 Dairy Farm DPO

Source: Dairy Farm’s 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 Dairy Farm a cash conversion cycle of -58 days for 2014 (48 + 9 -115 = -58).

What this means is that Dairy Farm is able to buy goods, sell it to its customers, and collect the cash from the sale roughly 58 days before it has to pay its suppliers. This would be helpful for Dairy Farm as it would require less cash to be tied up in the daily operations of its business.

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 owns shares in Dairy Farm.