A rising cash conversion cycle could be a reason for worry as it signifies unsold or unrealised inventory
22-Apr-2015 •Vikas Vardhan
The cash conversion cycle is the time taken by a company to convert its raw material or inputs into the cash flow realised from the customers. It is derived by adding inventory and debtor days and subtracting payable days.
A lower cash conversion cycle is obviously a desirable attribute, and over the time the ratio tells us about the efficiency of a company. A rising cash conversion cycle over the years means that working capital requirements are rising and a prolonged rise can put a company in trouble as well.
We checked the cash conversion cycle of 407 companies of the BSE 500 index, excluding banks, finance companies and the companies with insufficient history. We found that in the last five years the working capital requirement has risen for the majority of the companies, wherein 243 out of 407 companies have witnessed a rise in the cash conversion cycle. Even working capital loans for these companies have grown four times from an aggregate amount of ₹42,000 crore in FY10 to a massive 1,69,838 crore in FY14.
This is a big concern because working capital loans, which constituted only 3 per cent of the total debt in FY10, now account for more than 7 per cent.
Debt for business expansion may be healthy but the working capital loan is an unproductive loan which highlights operational inefficiencies, and hence should be analysed very closely.