The business that grows on its suppliers' money

Two companies crossed my desk last week with almost identical income statements. Same revenue, same margin, both growing nicely. One of them spent the whole year scrambling for cash and topping up a working capital loan. The other generated more and more cash the faster it grew. Same profit on paper, two completely different lives. The difference was not in the profit line at all.

It was in the cash conversion cycle. Take the days a company waits to collect from customers, add the days its stock sits in inventory, subtract the days it takes to pay its own suppliers. That number is how long the company's cash is locked up before it comes back.

Company A collects in 75 days, holds inventory for 90, and pays suppliers in 30. That is 135 days of its own money tied up in every cycle. Company B is the mirror image. Customers pay it upfront in 5 days, stock moves in 20, and it takes 60 days to pay suppliers. Its cycle is minus 35 days. The suppliers and the customers are funding the business for it.

Here is where it bites. Grow each one by Rs 100 crore of sales. Company A has to find Rs 37 crore just to fund the extra inventory and the invoices customers have not paid yet. Company B is handed roughly Rs 10 crore of spare cash for the same growth. A Rs 47 crore swing, and you will not find a hint of it on the profit line.

This is why some of the steadiest compounders barely borrow. A negative cycle is a free loan that scales with them. And it is why a quietly rising collection-days number, year after year, is worth more of your attention than one good quarter. The one that collects first and pays last rarely has to call the bank to grow

Where the Rs 37 crore goes

Break the cycle into its three parts and put rupees on each. For every Rs 100 crore of extra sales, a business needs its days divided by 365 times Rs 100 crore in each bucket. (Strictly, inventory and payables are measured against cost of goods, not sales. Using sales for all three keeps the sum simple and close enough to see the shape.)

Company A: receivables of 75 days tie up Rs 20.5 crore. Inventory of 90 days ties up Rs 24.7 crore. Suppliers waiting 30 days give back Rs 8.2 crore. Net, Rs 37.0 crore. Company B: Rs 1.4 crore in receivables, Rs 5.5 crore in inventory, and Rs 16.4 crore of supplier credit. Net, the business releases Rs 9.6 crore.

Five years of growth, two bank balances

One year of growth is a small number. Compounded growth turns it into the whole story. Give both companies Rs 1,000 crore of sales today, 20 percent growth a year for five years, and an 8 percent net margin.

Sales reach about Rs 2,488 crore. Across the five years they add Rs 1,488 crore of new sales and earn about Rs 714 crore of net profit. Company A has to put about Rs 550 crore of that into receivables and inventory, leaving Rs 164 crore. Company B gets about Rs 143 crore of extra cash from its cycle on top of its profit, for Rs 857 crore. Same income statement for five years. One has five times the cash of the other.

If Company A also wants to pay a dividend or build a plant, the Rs 550 crore has to come from a loan or new shares. At 10 percent interest, a Rs 550 crore working capital line costs Rs 55 crore a year, and that cost does land on the profit line, a few years after the cause.

Reading the three numbers from an annual report

1. Receivable daysTrade receivables on the balance sheet, divided by revenue from operations, times 365.
2. Inventory daysInventories divided by cost of materials consumed plus purchases, times 365.
3. Payable daysTrade payables divided by the same cost line, times 365.
4. Track five yearsThe level depends on the industry. The direction is what tells you something has changed.

The first number to drift is usually receivable days. A company pushing sales into distributors at the end of a year, or selling to weaker customers on longer credit, shows it here before anywhere else. The free Learn module on reading financial statements shows where each of these lines sits in an Indian annual report, and the post on EPS against free cash flow follows the same cash into the cash flow statement.