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Is Cash Rich Singapore Technologies Engineering Ltd A Buy?

“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 the sprawling conglomerate, Singapore Technologies Engineering Ltd (SGX:S63) – or better known as ST Engineering – through this calculation today. We will be using the figures for the financial year ended 31 December 2014 in this case.

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 ST-Engineering DIO

Source: ST Engineering’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 is good at credit management.

2014 ST-Engineering DSO

Source: ST Engineering’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 ST-Engineering DPO

Source: ST Engineering’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 ST Engineering a cash conversion cycle of 82 days for the financial year ended 31 December 2014 (126 + 73 – 117 = 82).

Its notable that ST Engineering was able to put off paying its suppliers (117 days) longer than it took to collect its payment from its customers (73 days).

That said, ST Engineering also maintained a DIO of 126 days. This was due to the sizable inventory and work-in-progress position that the conglomerate maintains on its balance sheet. In this case, it was the DIO which was the main contributor to the 82 days seen in the cash conversion cycle.

In all, the cash conversion cycle of 82 days would mean that business of ST Engineering would require working capital to finance. On the other hand, the conglomerate sports a good historical cash flow and has a strong balance sheet – these may be enough to help support the unfavorable cycle.

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

With that, the Foolish investor would be in a better position to decide if ST Engineering’s current share price provides an appropriate margin of safety and whether it fits into his or her portfolio.

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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.