We've all heard the mantra "cash is king." But a fistful of dollars today deserves the royal treatment more than a wad of cash down the road. We want our companies turning their products into cash -- fast!
The cash conversion cycle
Enter the cash conversion cycle. It tells us how quickly a company turns cash invested in inventory into cash in the bank after collecting credit sales from customers and paying off its suppliers. The more quickly a company can turn over its inventory, the more efficiently it's managing its assets. There are three components of the cycle, and here's how they operate:
-
Days Inventory Outstanding (DIO)
Inventory sitting on store shelves or in stockrooms is not doing the company, or the investor, any good. The number of days the inventory sits there measures how quickly management can get those Speedos off the racks and onto the beaches of Malibu. Obviously, lower numbers are better.
DIO = (average inventory/annual cost of goods sold) * 365 days
-
Days Sales Outstanding (DSO)
Outstanding sales are those the company hasn't yet been paid for; they're languishing in accounts receivable. We want our companies to not only make quick sales, but also get paid for them right away. The faster, the better.
DSO = (average accounts receivable/annual sales) * 365 days
-
Days Payable Outstanding (DPO)
While we want customers to pay us quickly, we want to take our sweet time paying our bills. By paying suppliers slowly, companies have more cash available to spend on things they need, such as inventory, so we want this number to be higher.
DPO = (average accounts payable/annual cost of goods sold) * 365 days
Putting it all together
With the three pieces of the puzzle calculated, we can figure out how long a company is taking to get paid for the products its customers are buying from inventory, minus the number of days it takes it to pay its suppliers. The cash conversion cycle, or CCC, equals DIO + DSO - DPO.
These companies make the hardware and software that the networking industry -- ISPs, cable operators, and telecom providers -- use to provide us with the voice and data services we use daily. So let's see which of them can manufacture the fastest way to bring home the cash.
|
Company |
DIO |
+ |
DSO |
- |
DPO |
= |
CCC |
CAPS Rating (Out of 5) |
|---|---|---|---|---|---|---|---|---|
|
Sonus Networks (NASDAQ:SONS) |
119.9 |
+ |
73.6 |
- |
39.3 |
= |
154.2 |
*** |
|
Cisco (NASDAQ:CSCO) |
39.0 |
+ |
36.4 |
- |
23.9 |
= |
51.5 |
***** |
|
Ericsson (NASDAQ:ERIC) |
82.6 |
+ |
107.9 |
- |
55.0 |
= |
135.5 |
*** |
|
Nortel Networks (NYSE:NT) |
109.7 |
+ |
85.2 |
- |
54.4 |
= |
140.5 |
* |
Each week, we look for the top companies in different industries that make fast cash. It seems that the 76,000 participants in the Motley Fool CAPS investor-intelligence database have better-than-average feelings for these particular firms, since the majority of them are rated three stars or better. Of course, this isn't a list of stocks to buy or sell -- just a jumping-off point for further research.
The Cisco kid
The difference between top-rated Cisco -- the company often associated with being the "backbone of the Internet" -- and troubled Nortel is starkly apparent in their respective cash cycles. Cisco was able to reduce its days sales outstanding by five days from the previous quarter, thanks to shipping more product and collecting on its receivables more quickly. Nortel, on the other hand, saw its inventories rise. It notched a nine-day increase in DSO because of billing issues and what it terms a seasonal decline in revenues.
More than 5,000 CAPS investors have cast their votes for Cisco, and 96% believe it will outperform the market. Some 97% of All-Stars -- CAPS investors who consistently outperform their peers over time -- agree. As CAPS player PennyBuyer notes, the company has a base of customers who will need it to support their own growth plans:
Cisco Systems was once the most valuable company in the world, during the 90's tech bubble. Not anymore, but huge information technology companies Google (NASDAQ:GOOG), Yahoo! (NASDAQ:YHOO), etc. rely on Cisco's [infrastructure] to expand into developing markets. So huge growth [opportunities] and low risk make it a buy.
Don't be foiled again
So which company will continue to be the big star of cash creation? At Motley Fool CAPS, tell us your picks, as you work with thousands of your fellow Foolish investors to uncover the best stocks and convert your money into cash profits. Best of all, it's absolutely free -- so get started today!
