Online stock filtering and screening by inventory turnover and receivables turnover
Cash flow is critical in running all businesses. Companies without healthy cash flow are very likely to go into financial trouble sooner or later.
In normal business operations, there are several factors that have great impact to the cash flow of the company, including:
- How fast can the company sell out its goods?
- How fast can the company collect the full payment from its customers?
The
first factor can be rephrased in layman terms as "how fast can the
company make money through its operations?", which is no doubt, the
faster the better. This can be reviewed by its inventory turnover rate.
When
the company's goods are stored in the warehouse or display rack, there
is storage cost involved. The value of the goods could also be
depreciated as they are approaching their shelflife expiry, or when
newer goods are introduced to the market which becomes more attractive
to the customers. Most importantly, the goods can only bring revenue to
the company after they are sold (or leased) to customers.
The formula to calculate inventory turnover is:
Inventory turnover = Cost of goods sold / Average value of inventory
Low inventory turnover rate indicates:
- Weak sales
- Over-stocking (too much goods produced or brought in)
This
can be resulting from poor marketing and/or poor sales to clear out the
inventory effectively. This can also be due to lack of customers'
purchasing interest to the goods, which could be:
- Price is set too high
- Product quality is too low
- Low demand
High inventory turnover rate indicates:
- Strong sales
- Insufficient inventory (not a good sign)
This can be resulting from effective marketing and/or aggressive sales. This can also be due to:
- Price is set too low
- Product is good that customers are willing to pay for its price
- High demand
Even
if a company achieved a consistently high inventory turnover rate, its
cash flow is yet affected by its receivables turnover rate.
There are generally 3 ways a business collect money from its customers:
- Advanced (prepaid) collection - customer paid before receiving the goods.
- Cash term collection - customer pay upon goods delivery.
- Credit term collection - customer is given interest-free period to make payment within a timeline (normally 7-days, 14-days, 30-days, 60-days, etc.) after receiving the goods.
The money that customers
owe to the company, normally due to credit terms, is called receivables.
It is a common sense that high receivables will tighten up the
company's cash flow, and, on the other hand, advanced payment collection
will have positive impact on the company's cash flow.
The common formula for receivables turnover is:
Receivables turnover = Total credit sales / Average accounts receivables
However, the formula used in Rakuten Trade Stock Screener is:
Receivables turnover = Total revenue / Average accounts receivables
This
could be due to the difficulty in separating the credit sales from the
revenue with the financial information made available to the investors.
A
high receivables turnover rate indicates that the company is effective
in collecting back the money owed by customers. A low receivables
turnover rate is normally a red alert to investors and bankers.
Here is an example to perform stock filtering and screening in Rakuten Trade based on the 2 turnover rates as mentioned above.
Login to Rakuten Trade online trading website, select the Stock Screener menu, add a new filtering criterion, and select Receivables Turnover (%). Set its minimum to 10%.
Then, add in another filtering criterion Inventory Turnover (%). Set its minimum to 10%.
You should be able to get a list of around 40-50 matching stock counters on your screen at this moment.
Note
that inventory turnover is generally industry-related, and you should
compare the inventory turnover rate of a company with its peers in the
same industry. For example, we expect a high inventory turnover rate in
the FMCG industry.
If you don't have a Rakuten Trade account to access to the Stock Screener above, you can use this link to open a new Rakuten Trade account for free, including no charge for opening new CDS account. By opening account with the link, you can get 500 RT Points
within 30 days upon your account activation. Beside that, if you start
your trading within the first 10 business days after account activation,
your first online trading brokerage fee will be rebated as additional RT Points as well.
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