Negative Cash Conversion Cycle and Negative Working Capital
(This
is for information purposes only. This should not be construed as a
recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial
adviser before taking any investment decision. Safe to assume the author has a vested
interest in stocks / investments discussed if any.)
There are several companies in India with negative cash conversion cycle (CCC or cash cycle for short). Cash conversion cycle is usually expressed in number of days. It indicates the ability of a commercial firm to convert its sales into cash more frequently.
The lower the cash cycle the better the efficiency of a firm, all else being equal. For example, the cash conversion cycle of Mrs Bectors Food Specialities Ltd, a food consumer company in India, is 44 days for the financial year 2021-22.
This is calculated by adding debtors days (28) to inventory days (54) and from the result subtracting the days payable (38) -- we get 44 days (= 28 + 54 - 38) as cash cycle. This means, the company is able to convert its sales to cash in cycles of 44 days. (for more on these terms, see weblink)
This company sells branded biscuits and bakery products, mostly to retail consumers. As such, it is able to get cash immediately for its sales resulting in a lower cash cycle.
Take another company, Chaman Lal Setia Exports, which has a CCC of 237 days for FY 2021-22. The
nature of the business is such the company has to maintain high
inventories, by buying rice from farmers and keeping it in warehouses -- thus increasing the working capital needs of the firm.
Its cash cycle 237 days is derived by: 68 (debtor days) + 184 (inventory days) - 15 (days payable).
Working capital indicates the ability of a firm to meet its cash needs for the day-to-day operations for the next 12 months. It is a measure of how liquid a firm is. The higher the working capital, the greater the finance cost for a firm.
Working capital and cash cycle are different, though they are inter-related. Working capital considers short-term borrowings of the firm; whereas, cash cycle ignores it.
In general, fast-moving consumer goods or FMCG
companies in India have negative working capital. Due to higher efficiency of their supply chains; and unorganised suppliers,
distributors and retail shops, the companies are able to postpone their payables and hold low inventories -- thus reducing their cash cycles.
The following is a representative list of Indian listed companies with low debt equity ratio and negative cash conversion cycle > data from Screener culled today >
As shown above, companies in FMCG, automotive, hospitals and cement sectors tend to have negative cash cycles signifying higher efficiency of the industries in particular and the companies in general.
Negative cash conversion cycle implies that a company is able to use stakeholders' money to run its day-to-day operations (more efficient working capital cycle).
When a company sells directly to consumers, such firms (like, FMCG, food, hospital services, etc.) get their cash immediately, but postponing their payments to suppliers -- resulting in negative CCC for the company.
On the other hand, when a company sells mostly to other big companies, such big companies delay payments -- hence, smaller companies tend to have longer cash cycles -- same is the case with companies dealing with government contracts as governments in general delay payments to contractors, etc.
Companies that hold leadership position in their respective industries are able to squeeze more out of their ancilliaries and suppliers, thereby enjoying negative cash cycles / working capital.
The following is a representative list of companies with high debt ratio having negative cash cycles >
To Sum Up
Cash conversion cycles differ from industry to industry and from company to company.
The lower the CCC (all else being equal), the better for the company -- meaning the company generates cash at faster intervals. The lower the cash cycle and working capital needs, the lower the finance cost for a firm.
Before making investments, an understanding of working capital cycles and cash conversion cycles of companies and their respective industries is a must.
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References:
Negative CCC / working capital screen (from Screener.in)
VR article 28Dec2022
VR article 18Jan2018
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Disclosure: I've vested interested in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if any.
Disclaimer: The analysis and opinion provided here are only for information purposes and should not be construed as investment advice. Investors should consult their own financial advisers before making any investments. The author is a CFA Charterholder with a vested interest in financial markets.
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He blogs at:
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