A profitable company can still go bankrupt. The cause is almost always working capital — the cash trapped in receivables, inventory, and payables. Reading working capital tells you whether a business is genuinely cash-generating or just accounting-profitable.
The Cash Conversion Cycle (CCC)
CCC = DSO + DIO − DPO
- DSO (Days Sales Outstanding): Receivables / (Revenue/365). How many days you wait to collect after sale.
- DIO (Days Inventory Outstanding): Inventory / (COGS/365). Days inventory sits before sale.
- DPO (Days Payables Outstanding): Payables / (COGS/365). Days you take to pay suppliers.
CCC = days between paying for inputs and collecting from customers. Lower (or negative) = better. Each day shorter releases cash to the business.
Sector benchmarks (typical CCC)
| Sector | Best-in-class CCC | Industry avg |
|---|---|---|
| FMCG (HUL, Nestle) | 15-30 days | 30-50 days |
| IT services (TCS, Infosys) | 60-80 days | 80-100 days |
| Cement (UltraTech) | 40-60 days | 60-90 days |
| Steel (Tata Steel) | 50-70 days | 70-100 days |
| Auto OEM (Maruti) | −5 to 10 days (negative!) | 20-40 days |
| Retail (DMart) | −15 to −5 days (negative) | 10-30 days |
| Real estate | 500-1000+ days | cash trap sector |
DMart and Maruti operate with NEGATIVE CCC — they collect cash before paying suppliers. Floating other people's money for free. That's the cleanest business model in retail/auto.
The 4 red flags
1. DSO rising while revenue grows
Means the company is growing revenue by extending credit to customers. Sales-stuffing or weak collection discipline. Often precedes write-offs.
DHFL FY18-FY19: DSO ballooned from 40 to 90 days while revenue “grew”. Bankrupt 6 months later.
2. DIO rising sharply
Inventory piling up = end demand weakening. The accountants haven't written it down yet, but the trucks aren't moving.
Auto OEMs FY19 (pre-COVID slowdown): DIO rose 30-40% in 2 quarters before quarterly results showed margin pressure.
3. DPO stretching to extreme
Paying suppliers later = cash flow stress masked. Eventually suppliers demand cash-on-delivery and the cycle breaks.
4. Other current assets growing fast
Often a dumping ground for stuff that should be written off — old receivables, doubtful loans, prepayments to related parties. Worth digging notes-to-accounts.
Reading the balance sheet — what to look for
- Total Current Assets growth: Should match revenue growth within ±10%. If much higher = working capital problem.
- Cash from Operations / Net Profit ratio: Healthy ≥ 0.8. Below means profit isn't converting to cash.
- Trade receivables turnover: Revenue / avg receivables. Higher = faster collection.
- Inventory turnover: COGS / avg inventory. Higher = faster sell-through.
The compounder check
Long-term compounders (HDFC Bank, TCS, Asian Paints, Pidilite) share one trait: stable or improving CCC over 10+ years. Cash conversion is the engine of compounding.
Conversely, value traps often have rising CCC even when P/E looks cheap. The market sees the cash stress before the earnings.
The screening filters
- CCC stable or improving over 3-5 years.
- Cash from Operations / Net Profit ≥ 0.8 over 3 years.
- DSO ≤ industry median.
- Inventory turnover ≥ industry median.
- Other current assets < 10% of total assets.
Pair with the Free Cash Flow guide and D/E ratio analysis for a complete balance-sheet read. Use the DCF calculator with realistic FCF inputs that account for working capital reality.