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Is Singapore Technologies Engineering Ltd A Cash Machine Stock to 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 conduct investing research on a 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 into inventory, sell that inventory, and receive the cash from the sale. In general, the shorter the cycle goes, the better it is for a company.

To learn how to calculate the cash conversion cycle, you can check out here.

Let’s run engineering conglomerate Singapore Technologies Engineering Ltd  (SGX: S63) through this calculation today. We will be using figures from the company’s financial years ended 31 December 2015 and 31 December 2014.

We start with the Days Inventory Outstanding (DIO) metric. DIO is the number of days it takes for a company to sell its entire inventory. Generally speaking, the lower the number of days, the more effective a company’s inventory management is.

Below is a summary table with all the relevant figures for the DIO calculation:

ST Engineering DIO table
Source: Singapore Technologies Engineering’s earnings report

Next up, we have the Days Sales Outstanding (DSO) figure. DSO represents the amount of time it takes a company, on average, to receive money after it has sold a good or service. Similar to DIO, having lower DSO usually indicates that a company is good at credit management.

ST Engineering DPO table
Source: Singapore Technologies Engineering’s earnings report

Finally, we come to 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.

ST Engineering DSO table
Source: Singapore Technologies 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. For 2015, ST Engineering had a cash conversion cycle of 93 days (140 + 76 – 123 = 93), an increase from the cash conversion cycle of 82 days recorded in 2014.

Notably, ST Engineering is able to put off paying its suppliers (123 days) longer than it takes to collect payment from its customers (76 days).

But, ST Engineering’s DIO for 2015 was 140 days, up from 126 days a year ago. The increase in DIO is the main contributor for the increase in its cash conversion cycle from 82 days in 2014 to 93 days in 2015.

Over time, tracking the changes in the cash conversion cycle of a company may help the Foolish investor better understand the business changes that the company is undergoing 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.