In earlier blogs I have told you about ROE AND ROCE. They tell us how well the company is managing the capital employed into its business through debt or equity, But there are few more parameters which you can look up to understand the fundamentals of their business
To understand a cash cycle lets take an example
- Suppose you want do a T shirt business for which you need metric tones of sheet clothe to make T shirt out of it.
- You order this sheet of clothe on 1st May and pay the money to the supplier.
- You start making T shirt out of it and it takes you 10 days of time to complete whole order.
- Now you start selling these T shirts and it takes 20 days to completely sell all the T- shirts.
- At the end of month you got your money back which you invest on 1st may with some profits.
- So it took 10+20 days to get your money back so you are cash cycle will be 30 Days.
Lets see a real life scenario example for this concept.
Now here if you may observe the cash cycle is -6 days. You may be thinking how come this is possible? -6 really? Wait i will explain you this negative cash cycle by an example.
Radico Khaitan is in alcohol Business.
- Radico khaitan takes raw material from the supplier to make alcohol and says it will make the payment for raw material after 40 days.
- Now the supplier as it maybe a big order and who wants to lose a big client like Radico khaitan , so he agrees [He thinks even if i got payment after 40 days whats the issue as the order maybe large]
- Now being such a big company Radico khaitan doesn’t needs 20 days to manufacture the products.
- With its strong distribution network and the demand within 7 days of purchase of raw material Radico will be able to sell all the products made by the raw material
- But do you remember Radico khaitan has told the supplier it will make the payment after 40 days.
- So still 33 days are left to make the payment and even without spending a penny Radico khaitan has got all the money it invested[of course they will pay it after 40 days ,no one is giving you materials for free] with profit.
- So In this whole scenario Radico Khaitan has a cash cycle of -33 days[according to this example].
So this cash cycle also tell us how much reputed the company is in the market and suppliers are even ready to give their supplies to these company by taking payment afterwards.
Summary:- Cash Cycle should always be less or if its negative then its very good sign to invest in the company!
Even if a company is generating more revenue or growing by sales that doesn’t mean they are doing a good business. They are few more parameters you should look up to before coming to a conclusion to invest.
Asset turnover basically tells how much money or return the company is generating over the asset it has. If you look at the asset turnover of Radico Khaitan it is around 3.61 . What it means?
It means that if Radico Khaitan has Rs 100 as asset, it is generating 3 times (asset x 3.61) times money or return which is actually good.
By these two parameters we can actually evaluate how well the company is established and how good they are doing business in their market