“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 food and beverage retail outfit BreadTalk Group Limited (SGX: 5DA) 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:

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 the DIO number, a lower DSO is an indication that a company is good at credit management.

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.

Pulling it together

The cash conversion cycle can now be put together by adding the DIO with DSO and subtracting the DPO . For 2015, BreadTalk Group had a cash conversion cycle of a negative 72 days (12 + 34 – 118 = -72), a slight decrease from the negative 80 days recorded in 2014.

Having a negative cash conversion cycle of 72 means that BreadTalk Group is able to buy raw ingredients, convert them into food products, sell them to customers, and collect the cash from the sale, roughly 72 days before it has to pay the suppliers of the raw ingredients.

This would be helpful for BreadTalk Group as it means that the company requires less cash to be tied up in its daily business operations. Notably, BreadTalk Group is able to maintain low inventory levels.

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 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.