Why use your own money, when you can use someone else’s for free?
This is precisely what Dell Inc. (DELL) does as shown by its negative cash conversion cycle.
The cash conversion cycle measures the time it takes a company to convert sales into cash. It is calculated as the Days of Sales Outstanding plus the Days of Inventory less the Days of Accounts Payable. To explain this more clearly, the longer sales are outstanding, and the longer inventory sits around, the worse it is for the company (which has already paid for the parts that make up the inventory and the items sold on receivable). Likewise, the longer the company can delay paying its suppliers, the better (since the company can use that cash for its own purposes in the meantime – essentially an interest-free loan).
The following chart from Dell’s recent 10-K depicts its cash conversion cycle (click for full size):
The most important thing to note here is that DELL’s cash conversion cycle is negative. From the chart, we see that Dell is able to use cash collected for a month for free, courtesy of its suppliers.
[W]hile a firm could even achieve a negative CCC by collecting from customers before paying suppliers, a policy of strict collections and lax payments is not always sustainable.
However, going through DELL’s past 10-Ks, I see that the company has been able to accomplish this for more than a decade!
Let’s compare this to Hewlett Packard (HPQ) (click for full size):
So, DELL gets free use of its suppliers’ cash for more than a month, and HPQ does not. In a low interest rate environment, this may not provide a large benefit to DELL. From the tables,we see that the biggest difference is the inventory levels, indicative of DELL’s competitive edge in efficient inventory management.
Author Disclosure: Long DELL, HPQ