Is Cash Rich Petra Foods Limited 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 to 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 chocolate confectionary maker Petra Foods Limited (SGX:P34) through this calculation today. We will be using figures from the firm’s 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 Petra DIO

Source: Petra Foods’ 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 Petra DSO
Source: Petra Foods’ 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 Petra DPO

Source: Petra Foods’ 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 Petra Foods a cash conversion cycle of a hefty 102 days for the financial year ended 31 December 2014 (77 + 59 – 34 = 102).

It’s notable that Petra Foods takes more time collect payment from its customers (59 days) as compared to its payment terms with its suppliers (34 days). When you throw in a DIO level of 77 days, this quickly pushes the company towards a cash conversion cycle of 102 days.

In all, the cash conversion cycle of 102 days would mean that Petra Food’s business would require working capital to finance. At the end of 2014, the chocolate confectionery maker had a net cash position which may help.

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 all the above in mind, the Foolish investor would be in a better position to decide if Petra Food’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.