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Is Debt Laden Golden Agri-Resources 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 convert cash in the bank to inventory, sell that inventory, and then 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 Golden Agri-Resources Ltd (SGX: E5H) through this calculation today. We will be using figures from the firm’s financial year ended 31 December 2014 in this exercise.

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 Golden Agri DIO

Source: Golden Agri-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 Golden Agri DSO

Source: Golden Agri-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 Golden Agri DPO

Source: Golden Agri-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 Golden Agri-Resources a cash conversion cycle of a hefty 43 days for the financial year ended 31 December 2014  (49 + 25 – 31 = 43).

It’s notable that Golden Agri-Resources takes less time to collect payment from its customers (25 days) as compared to the time it takes to pay its suppliers (31 days). That said, when you add in a DIO level of 49 days, this pushes the palm oil outfit towards a cash conversion cycle of 43 days.

In all, the cash conversion cycle of 43 days would mean that Golden Agri-Resources’ business would require working capital to finance. At the end of 2014, the company had US$323 million in cash and equivalents but a hefty US$3.1 billion in debt. The huge net-debt position, along with the need for working capital in its business, adds risk to the overall financial picture for Golden Agri-Resources.

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 Golden Agri-Resources’ 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.