Receivable days represent the number of days customers are taking to pay a company for its sales. We calculate receivable days using the following formula:
= 365 / (Sales / average of trade receivables outstanding at the start of the year and at the end of the year)
Effectively, receivable days represent the number of days (credit period) that customers take to settle their dues to the company. If the customers pay in full when they buy something from a company, then it would have receivable days of zero. If the customers pay the money a month after getting the goods, then the company would have receivable days of 30 days.
In normal business practices, companies that sell to retail customers (i.e. B2C) usually have lower receivable days because they sell to individual customers by collecting all the payment upfront at the time of sale. Whereas the companies that sell to other companies (i.e. B2B), they give their customers some time for payment after the sale. Normally, this period is 30 to 45 days and may stretch to 60 days in some cases. However, credit periods beyond 60 days are longer than common business practices and demand deeper analysis by investors.
Receivable days: A negotiation war:
An investor may think that ideally, companies should give as low credit period as possible so that they reduce the risk of a customer not paying after delaying payments for a long time. In addition, when the company get money from its customers at the earliest, then it can avoid using Bank’s money for its day to day activities and therefore, it can reduce its finance costs.
However, if a company forces very strict payment terms on its customers, i.e. it asks early payments, then other competitors may offer better payment terms and take away its customers. Therefore, companies need to keep a well thought out policy for giving credit period to their customers.
Nevertheless, an investor would appreciate that the credit period given by the company to its customers is one thing. When the customer would actually pay the company is another. The customer may choose to pay the company at its own sweet time and convenience. If the customer knows that the company is in a weaker negotiating position, then it might delay the payments to the company much beyond the agreed payment period. At times, if the customer is not happy with the goods or services provided by the company, then it may refuse to pay at all.
All these instances of payment delays by the customers result in increasing trade receivables for the company and in turn, increase its receivable days. Therefore, an investor would appreciate that continuously increasing receivable days are a cause for concern.
Implications of delayed receivable days:
If the customers of a company delay payments, then the company may need to take loans to manage its day to day expenses like purchase of raw material, payment of salaries, electricity bill payment etc. This in turn increases the finance cost for the company.
An investor would note that if a company is selling the products to customers and in turn reporting revenue and profits in its profit & loss statement (P&L); however, it is not getting money from its customers, then its cash flow from operation (CFO) would be lower. In such situations, an investor would note that the profit after tax (PAT) of the company would not translate into CFO. In such companies, if an investor compares the total net profits for the last 10 years (cPAT) with the total cash flow from operating activities (CFO) for the last 10 years (cCFO), then she would note that the cCFO would be lower than cPAT. At times, companies would have to rely on debt to meet the gap i.e. they would have to take loans to meet their day to day expenses. This would lead to an increase in debt year on year and in turn, would lead to a higher interest expense.
Therefore, an investor should appreciate that every company would want to collect its money at the time when it is due for payment and any delays beyond it may mean that some problems that need attention. An investor should analyse receivable days of any company with this information at the back of her mind.
A) Common situations that have higher receivable days:
As discussed above, whenever the customer believes that it can push the suppliers for a longer credit period, then it will delay the receivables. In addition, whenever there is any dispute between the customer and the supplier e.g. quality of the product, the achievement of the milestones in the projects etc., then the receivables would be delayed. An investor may appreciate that there can be many genuine situations where a company may not get payments from its customers and in turn may report higher receivable days.
Let us see some of the typical situations with examples of real-life companies that faced higher receivable days.
1) Companies selling commoditized products have very low negotiating power over customers:
Whenever an investor comes across a company selling a commoditised-undifferentiated product, then she should understand that the customers who use such a product would have an option to choose from many suppliers. The customers may easily replace the product of one company with the product from another company without a significant impact on their functioning. As a result, in the cases of companies that sell commoditised products that are not significantly different from their competitors, they are not able to have a strong negotiating power over their customers.
In such businesses of selling commoditised products, a company may, in fact, need to give a higher credit period to the customers as an incentive to buy its products. Moreover, a customer may knowingly delay payments to the company as he/she knows that the company would have to keep supplying it in order to stay in the business.
Therefore, the companies selling low-technology, commoditised-undifferentiated products usually have high receivable days.
Let us see examples of some companies selling commoditized products that face the challenges of high receivable days.
i) HEG Ltd:
HEG Ltd is one of the leading graphite electrode manufacturers in India.
While analysing HEG Ltd, an investor notices that the customers of graphite electrode manufacturers are steel manufacturers, which usually are very large corporates. These large customers usually have a lot of negotiating power and therefore, demand high credit period from the suppliers. Therefore, in the graphite electrode industry including HEG Ltd, the receivable days tend to be high.
An investor notices that over the years, receivable days of HEG Ltd has been ranging from 120 days to 150 days indicating that the customers of the company demand significant credit period.
While looking at the overdue details of the receivables of HEG Ltd in the FY2018 annual report, an investor notices that almost 25% of the receivables of the company are overdue with the customers failing to pay them at agreed-upon dates. Some amount of receivables are due for more than 2 years from the time these were to be paid by the customers to HEG Ltd.
FY2018 annual report, page 198:
The working capital intensive nature of the graphite electrode manufacturing business is also highlighted by the credit rating agency, India Ratings in its report for HEG Ltd in Dec 2018:
HEG’s business is working capital-intensive because graphite electrode manufacturing involves a large processing period and a moderate to long credit period to customers. This is inherent in the graphite electrode manufacturing space.
Further advised reading: Credit Rating Reports: A Complete Guide for Stock Investors
The recent improvement in the receivable days in FY2018 and FY2019 to 89 days and 60 days respectively seems to be a result of the newly found negotiating power in the graphite electrode manufacturers that resulted due to sharp increase in the demand for their products in FY2018-FY2019. However, the demand improvement turned out to be cyclical and the company has reported operating losses in FY2020 and its receivable days are back to its historical trend of 135 days in FY2020.
An investor may read our complete analysis of HEG Ltd in the following article: Analysis: HEG Ltd
ii) Vikram Thermo (India) Ltd:
Vikram Thermo (India) Ltd is an Indian player active in manufacturing pharmaceutical excipients and other chemicals under brands: DRUGCOAT, DRCOAT and DPO.
While analysing Vikram Thermo (India) Ltd., an investor notices that the product of the company “excipients” is the inert material that is mixed with active pharmaceutical ingredient (API) to create medicinal tablets. An investor may understand it as following: a tablet of Paracetamol (a drug to reduce fever) has two components; the real drug Paracetamol and the remaining white power that holds the drug together and makes it easy to swallow. This white power is called “excipient” and is the main product of Vikram Thermo (India) Ltd.
The customers of Vikram Thermo (India) Ltd are pharmaceutical companies who manufacture and sell drugs like Crocin (Paracetamol). An investor would appreciate that excipient is a low value-adding part of the drug and the pharmaceutical companies have a large number of supplier willing to sell them excipient. These pharmaceutical companies are usually large organizations and have a higher negotiating power over suppliers of excipients like Vikram Thermo (India) Ltd.
Therefore, an investor is not surprised to see that Vikram Thermo (India) Ltd has consistently had very high receivables days exceeding 120 days over the last 10 years.
An investor may note that it might be the large pharmaceutical companies that have an option to buy excipients from many suppliers, who have pushed Vikram Thermo India Ltd to give them higher receivable days. Alternatively, it might be Vikram Thermo India Ltd who has offered a longer credit period to its customers (large pharmaceutical companies) as an incentive to buy low-value-adding excipients from it.
In whatever way an investor may perceive it, the end result is that the manufacturer of a low value-adding and commoditised product faces higher receivable days from its customers.
An investor may read our complete analysis of Vikram Thermo India Ltd in the following article: Analysis: Vikram Thermo India Ltd
Let us now see what are other common causes of higher receivable days for companies.
2) Companies doing project work where payments are linked to achievement of milestones:
When companies are involved in project-related work, then usually, the release of payment by the customer is linked to the achievement of certain milestones spread across the life of the project.
In almost all the cases where the payments are linked to the achievement of milestones, we notice that the instances of disagreements between the customers and the suppliers related to proper achievements of milestones are very frequent. As a result, many times, the suppliers raise the bill; however, the customers keep on stressing for more work being done to their satisfaction before releasing payments. Therefore, the delay of payments in the normal course of business is very frequently seen.
In addition to the disputes related to the achievement of project milestones, companies doing project work face another problem. Companies face additional difficulties in realizing payments from the projects that are not doing well, the projects that have seen long delays due to difficulties in funding, wrong strategic direction, improper execution etc. In such delayed projects that witness time and cost overruns, the payments to all the suppliers are under problem. Many times, suppliers do not receive the payments for their work at all and it leads to bad debt i.e. non-recoverable receivables.
Therefore, whenever investors come across companies involved in project work, then they should be aware of these risks around recovering money from the customers.
Let us see examples of real-life companies doing project work that have faced problems in recovering money from customers.
i) WPIL Ltd:
WPIL Ltd is an Indian company involved in fluid handling by way of making pumps and execution of turnkey water supply projects for irrigation, oil & gas, power, and other industries.
While analysing WPIL Ltd, an investor notices that the company has had high receivable days over 120 days and at a time going up to 175 days in FY2015.
The nature of the business of WPIL Ltd, which includes convincing the customer about meeting the milestones for release of payment, has historically resulted in high receivable days.
In recent years, when an investor analyses the patterns of receivables dues, then she realizes that at any point in time, a large amount of the receivables of the company are overdue. Some of the receivables are overdue for more than a year from the date they were supposed to be paid to WPIL Ltd.
FY2019 annual report, page 185:
As per the above table, in FY2019, about ₹25 cr of receivables were due for more than one year since the date they were supposed to be paid by the customers. The similar number for FY2018 was even high at ₹73 cr.
An investor would appreciate that in cases of such high delay in collection of receivables, usually, there are underlying disagreements between the parties about whether the money is due at all and if it is due then the amount of money that is due. In such cases of disagreements, usually, it becomes difficult for companies to collect the complete amount of money. As a result, companies witness frequent bad debts i.e. they are not able to collect the stated amount of receivables and in turn, write them off.
The situation is no different for WPIL Ltd. While reading the past annual reports of the company, an investor notices that the company had to write off receivables almost every year.
- In FY2019, it wrote off ₹11 cr and in FY2018, ₹10 cr. In addition, the company provided for about ₹4 cr of additional bad debts. FY2019 annual report, page 171:
Similarly, in the past, the company wrote off receivables every year. In FY2017 (₹2.6 cr), FY2016 (₹1.9 cr), FY2015 (₹2.3 cr), and in FY2014 (₹1.3 cr).
In FY2013, the problem of delayed receivables hit the company hard and as a result, WPIL Ltd decided to cut off supplies to those customers who were not paying it on time. As a result, the company reported that its business suffered and it reported lower sales.
FY2013 annual report, page 6:
The turnover registered marginal drop compared to last year due to conscientious monitoring and withholding of dispatch to certain customers for delay in execution and clearing dues following liquidity tightness.
Moreover, the company realized that delays in collecting money from its customers can destabilize its business and highlighted the same to the shareholders in the FY2013 annual report.
FY2013 annual report, page 9:
The biggest concern presently is the domestic industrial environment along with credit worthiness of large clients.
FY2014 annual report, page 21:
The biggest concerns are the volatile raw material prices and impact of surging inflation on the other item of inputs and poor recovery from customers.
The credit rating agency, CARE also highlighted this aspect of delays in collection of receivables by the company as one of the risk factors. CARE disclosed the delayed receivables and the resultant working capital intensive nature of its business in its report for WPIL Ltd in Oct. 2019.
The ratings continue to be constrained by the susceptibility of profitability to volatility in raw material prices, working capital intensive nature of operations marked by high collection period and competition in the pump industry due to fragmented industry structure.
An investor would note that from FY2011 to FY2020, the trade receivables of the company have increased from ₹120 cr to ₹321 cr. It indicates that over FY2011-2021, ₹201 cr of funds of WPIL Ltd were stuck in its working capital because of trade receivables.
An investor may read our complete analysis of WPIL Ltd in the following article: Analysis: WPIL Ltd
Therefore, an investor would appreciate that when companies engage in project-work, then there is a high probability that they would face challenges while recovering money from their customers.
Let us now see another common factor where companies face challenges in recovery money when companies work for govt. agencies or departments.
3) Companies that work for govt. agencies usually have high receivable days:
While analysing different companies, an investor would notice that the companies that work for govt. agencies and departments usually face delay in getting their money released from such agencies. As a result, such companies usually report higher receivable days.
This aspect becomes apparent when an investor analyses companies that work for govt. agencies. Let us see an example of such a company.
i) Skipper Ltd:
Skipper Limited is a leading Indian manufacturer of transmission towers and PVC pipes. Skipper Ltd.’s products are used in the erection of power transmission and distribution lines where most of the projects are executed under the purview of govt. agencies.
While analysing Skipper Ltd., an investor notices that over the last 10 years, the company has consistently had high receivable days in the range of 80-90 days, which have increased to 122 days in FY2020.
The company operates a business, where it needs to get the funds released from Govt./PSU enterprises. Many times, collecting receivables from PSU organizations may take some time, which might be a reason for relatively high receivables.
An investor may read our complete analysis of Skipper Limited in the following article: Analysis: Skipper Limited
4) Companies with a concentration of customers have the risk of high receivable days:
When any company has only a few customers contributing to a very large percentage of its overall business, then the key customers may take an advantage of the dependence of the company on them. Large customers know that the supplier is in a weak negotiating position because the supplier cannot let go of its largest customers without a significant impact on its business.
In such a situation, the key customers may negotiate a longer credit period or may delay the payments voluntarily because they know that the company would hesitate to break the business relationship with them.
Let us see an example of such a situation where a company with a concentration of customers is facing high receivable days.
i) Sonata Software Ltd:
Sonata Software Ltd is involved in providing information technology services to international clients and software distribution business in India. The company provides solutions oriented around Microsoft Dynamics 365, SAP Hybris and other platforms to travel, retail, distribution industries among others.
While analysing Sonata Software Ltd, an investor notices that the company has high receivable days of 60-70 days.
From the above table, an investor notices that the receivable days of Sonata Software Ltd have consistently increased over the years. The company used to have receivable days of 47 in FY2012, which has steadily increased to 74 days in FY2019 and FY2020.
Looking at the increasing receivable days, an investor may appreciate that the customers of Sonata Software Ltd have a higher negotiating power and as a result, are able to get better payment terms from the company.
While analysing the customer profile of Sonata Software Ltd, an investor notices that the company has a high customer concentration. The contribution from the top 10 customers for the company is very high at about 70% in recent times. Moreover, the contribution from the top 10 customers for Sonata Software Ltd has been high consistently for the last 10 years.
In FY2011, the company got 78% of the business of International IT Services from the top 10 customers.
FY2011 annual report, page 10:
Top 10 clients contribute 78% of revenues of our IT services business.
In FY2018 and FY2019, the contribution from the top 10 customers was 70% and 68% respectively. The credit rating agency, CRISIL has also highlighted customer concentration as one of the key risks for Sonata Software Ltd in its April 2020 report for the company.
For fiscal 2019, the top 10 customers accounted for 69% of SSL’s revenue (70% in fiscal 2018). Given its modest scale of operations (compared to larger peers), SSL’s business risk profile will remain vulnerable to client concentration risk.
An investor would appreciate that due to concentration of revenue from a few customers, Sonata Software Ltd is in a situation where it cannot afford to let go of any of its large customers without a significant impact on its business. As a result, the company seems to accept extended payment terms from its customers.
The company had to face the impact of client concentration risk in Q4-FY2020 when the business of one of its largest clients that contributed about 15-20% of the revenue of the company was severely impacted due to coronavirus.
May 2020 conference call of Sonata Software Ltd:
Palem Srikar Reddy: ..we had this 1 single large client in the travel sector, who was contributing between 15% to 20% of the revenues of the company, and they had to more or less suspend the majority of their operations.
As a result, it does not come as a surprise to the investor that the large customers seem to be able to get increasingly lenient payment terms from Sonata Software Ltd leading to an increase in receivable days over the years.
An investor may read our complete analysis of Sonata Software Ltd in the following article: Analysis: Sonata Software Ltd
Until now, in the article, we have discussed common situations that lead to high receivable days. Now let us focus on the exact opposite scenarios where companies have reported low receivable days.
B) Common situations that have low receivable days:
Earlier in the article, we noticed that the companies that sell low-technology, commoditised, and undifferentiated product, have a low negotiating/pricing power over their customers. Such companies tend to have high receivable days. On the contrary, when an investor analyses companies that have strong pricing power over their customers, they tend to have low receivable days. In addition, we have noticed that companies that sell directly to the retail customer, have low receivable days.
Therefore, while analysing multiple companies, we have come across some common features in the companies that report low receivable days i.e. less than 30 days. Let us try to analyse those features with examples of real-life companies.
1) Companies with strong pricing power have low receivable days:
An investor would appreciate that if a company has a strong pricing/negotiating power over its customers, then it is only possible when the customers get some product from the company that is not easily available in the market, is a differentiated product and the customer derives significant value from it. Therefore, the customers are willing to pay a high price to the company when the raw material prices increase. In such situations, an investor would notice that the customers are also willing to clear the payments of the company quickly without any delays as they want to ensure the smooth supply of goods from the company without interruptions.
Let us see examples of companies that enjoy good pricing power over their customers and have low receivable days.
i) Supreme Industries Ltd:
Supreme Industries Ltd is a plastic goods manufacturer in India. The company manufactures plastic pipes, plastic furniture, cross-laminated films, protective packaging, composite LPG cylinders etc.
While analysing Supreme Industries Ltd, an investor notices that the company consistently has its receivable days in the range of 20-25 days. In FY2016, the company reported receivable days of 29; however, it was because the company has changed its financial year from June-end to March-end and therefore, it reported only 9-months of sales in FY2016.
While looking at the financial performance of Supreme Industries Ltd, an investor notices that the company has a good pricing/negotiating power over its customers, which is visible in the form of consistent operating profit margin (OPM) of the company over last 10 years.
The company has intimated to its shareholders over the years that it can pass on the increase in its raw material costs to its customers. The company passes on the increase in raw material costs to its customers with a gap of a few weeks.
FY2008 annual report, page 9:
In our Company’s product segments, the increase in raw material costs could be transferred to the product pricing within a time lag of 2 to 5 weeks.
FY2012 chairman’s speech, page 2:
Company is able to pass on the increased cost on all its products except commodity furniture.
The credit rating agency, CRISIL has highlighted this aspect of the business model of Supreme Industries Ltd in its report in July 2020.
Supreme is susceptible to volatility in the prices of key raw materials, polyvinyl chloride, high-density polyethylene, and polypropylene, which are affected by change in crude oil prices and foreign exchange rates, albeit partly offset by its ability to pass on price fluctuations to the consumers.
Therefore, an investor would notice that the strong pricing/negotiating ability of Supreme Industries Ltd over its customers allows it to get payments from them quickly without many delays.
An investor may read our complete analysis of Supreme Industries Ltd in the following article: Analysis: Supreme Industries Ltd
2) Companies that sell directly to end-customer and cut-down supply chain intermediaries, have low receivable days:
An investor would appreciate that the companies that sell directly to the end-customer, they are able to collect full payment from the customer at the time of sale before handing over the goods to the customer. Such an arrangement ensure that the companies do not run the risk of non-payment from the customer after he/she has used the goods. As a result, such companies have low receivable days.
Let us see examples of such companies that sell goods directly to the retail customer and has low receivables.
i) Sreeleathers Ltd:
Sreeleathers Ltd is one of the leading footwear companies in India based out of Kolkata. It deals in formal and casual footwear of men, women and kids as well as in leather accessories.
While analysing Sreeleathers Ltd, an investor notices that the company sells its goods directly to the retail customers through showrooms and collects full payment upfront at the time of sale. Therefore, an investor notices that the company has very low receivable days of about 1-2 days.
An investor may read our complete analysis of Sreeleathers Ltd in the following article: Analysis: Sreeleathers Ltd
An investor would notice that receivable days of 1-2 days for a business that sells directly to retail customers is in sharp contrast to other businesses that sell commoditized, and undifferentiated product and rely on distributors to generate sales.
An investor notices such a situation in the case of Quick Heal Technologies Ltd that relies on distributors to sell its products.
Quick Heal Technologies Ltd:
Quick Heal Technologies Ltd, an Indian company providing security software solutions like antivirus, antispyware, antimalware etc. to retail consumers under brand Quick Heal and to enterprise & govt. segment under brand Seqrite.
The company has reported high receivable days exceeding 110 days over the years, reaching to 153 days in FY2020.
While analysing Quick Heal Technologies Ltd, an investor notices that the company sells its products via distributors. Moreover, these distributors are not exclusive for Quick Heal Technologies Ltd. In fact, they sell antivirus products of its competitors as well and at times, the distributors sell their own antiviruses as well and thus, they turn into direct competitors of the company.
FY2019 annual report, page 50:
Our agreements with channel partners are non-exclusive, meaning our partners may offer customers software security products from other companies, including products that compete with our solutions. If our channel partners do not effectively market and sell our solutions or choose to use greater efforts to market and sell their own solutions or the solutions of our competitors, our business operations will be adversely affected.
The company told investors that it recognizes a sale of antivirus when it sends the antivirus to the distributor. The actual sale of antivirus to the end/retail customer may take next 2-3 months.
As per the discussion in the May 2019 conference call, page 9, the management highlighted that the sales revenue reported by the company is not the actual purchase by the end-users/consumers. Quick Heal Technologies Ltd mentioned that the reported sales revenue is actually the sales to the distributor.
Vijay Mhaskar: So the numbers that we talk about here is actually the billing numbers as we are in a stock and sell model, so it does not reflect actually on the product being actually consumed in the market that is activation numbers. Activation we are seeing pretty good numbers at this point. I do not think it is actually about the product that we are getting billed into the primary distributor or T1 distributor right, so that is where we have seen a drop and I mentioned earlier we had some disruption into the distribution channels primarily because the laptop and desktop OEMs they had some practices, which caused the cash rotation problem with the distributors, so number of them had their cash locked-in which impacted their investment that they could do into other businesses and because we have overlap between the distribution channel for the hardware products and the consumer security products, we had to suffer that and essentially it actually impacted our ability to recover the outstanding and in a way impacted our billing for Q4.
Saurabh Jain: But the distributor will actually buy the product if there is a demand for it in the retail end even though he might sell it after say a month or two months?
Vijay Mhaskar: The distribution channel is three tiers, so by the time he bills the product, by the time it flows to Tier-3, it takes almost two to three months. So there is usually enough stock in the market, so there is no need to do.
Further advised reading: How to do Business Analysis of a Company
In such a situation, when the distributor can easily sell an alternative antivirus product to the consumer, it is difficult to assume that Quick Heal Technologies Ltd would have the power to force strict receivable collection from the distributors. In case of excessive follow up by the company for the collection of receivables, a distributor can threaten to remove the products of Quick Heal Technologies Ltd from its shelf/catalogue.
In addition, the distributors do not buy antivirus products of Quick Heal Technologies Ltd for their own consumption. The distributors are traders who earn revenue by selling these antivirus products to next tier of distributors or consumers. Therefore, an investor can anticipate that the distributor who has bought antivirus products from Quick Heal Technologies Ltd will normally hesitate to pay money to the company unless it has sold the products to consumers/next tier of distributors. In case, the distributor is not able to sell the products of Quick Heal Technologies Ltd to other consumers, then in most likely cases, it will delay payments to the company.
This aspect of nature of sales of Quick Heal Technologies Ltd coupled with the negotiation power wielded by the distributors exposes the company to high credit risk. In the case of lower sales, the distributors may delay payments to the company or in some case may refuse to pay the money.
An investor may think of a situation where a distributor has many compact discs (CDs) of Quick Heal antivirus on its shelf, which it has taken from the company on credit. In case, the distributor finds that these CDs are not selling despite being on the shelf from many months, then the investor may try to imagine the willingness of the distributor to pay money to Quick Heal Technologies Ltd for these unsold CDs at the end of credit period of 30-60 days. It is very likely that if Quick Heal Technologies Ltd puts pressure for collection of receivables from the distributor for these unsold CDs on its shelf, then the distributor may ask the company to wait until these CDs are sold, or take back the CDs. In any case, the distributor has the option to sell other competing antivirus products to its consumers.
Therefore, an investor would appreciate that Quick Heal Technologies Ltd seems to have low power to collect receivables from its buyers who are distributors. The company has highlighted this risk in its FY2019 annual report, page 52.
Exposure to high credit risk: AV retail industry predominantly work on Stock and Sales model. This being a hypercompetitive industry, heavy stocking at all levels plays a pivotal role in driving market share. We rely significantly on our channel partners to sell and support our solutions and we expect that sales through our channel partners will continue to account for a significant percentage of our revenues. Weakness in the end user market could negatively affect the cash flow of our channel partners or distributors and resellers, who could, in turn, delay making payments to us and impact our working capital. We typically offer our channel partners around 60 days of credit. Furthermore, a change in the credit quality at one of our channel partners or other counterparties can increase the risk that such counterparty is unable or unwilling to pay amounts owed to us, which could directly or indirectly have a material adverse effect on our results of operations.
In light of the above discussion, an investor would appreciate that Quick Heal Technologies Ltd is not in a very strong position to collect money from its distributors for the sales reported by it in the financial statements. The distributors tend to delay the payment due to the higher negotiating power enjoyed by them. As a result, the company has continuously reported higher actual receivable days of more than 110 days than the normal credit period of 30-60 days.
An investor may read our complete analysis of Quick Heal Technologies Ltd in the following article: Analysis: Quick Heal Technologies Ltd
From the above discussion, an investor would notice that if a company sells its goods directly to the retail/end customer without depending on the distribution channel, then it tends to have low receivable days because it can collect entire payment upfront at the time of sale.
Let us see an example of another company that sells its services directly to the end customer and enjoys low receivable days.
ii) Just Dial Ltd
Just Dial Ltd primarily provides local search services where users can find out sellers of different products and providers of different services in their area. The company also provides digital onboarding services to small & medium enterprises (SMEs) like JD Omni.
While analysing Just Dial Ltd, an investor notices that the company has almost nil trade receivables and as a result, it has zero receivable days.
While analysing the business of the company, an investor notices that Just Dial Ltd sells advertising packages to SMEs and it directly collects money in advance from them. Therefore, the company does not have receivables on its balance sheet and in turn, it has avoided the risk of bad debt.
FY2020 annual report, page 46:
Just Dial follows a prepaid model for its various paid subscription plans. Customers can either pay upfront for the entire tenure or through monthly advance payment plans through ECS. Owing to this policy, it enjoys negative working capital and no receivables.
An investor may read our complete analysis of Just Dial Ltd in the following article: Analysis: Just Dial Ltd
Therefore, an investor would appreciate that if a company sells its goods or services directly to the end customer and does not have an intermediary channel, then it can collect entire payment upfront and have lower receivable days.
Until now, in the article, we have discussed common business conditions that lead to high or low receivable days for companies. Let us now discuss some solutions that companies use to get their money early despite offering a longer credit period to their customers.
C) Companies use bill discounting to get money early despite a longer credit period to customers:
Many times, companies are able to get a loan against their trade receivables from banks. If the customer who has to pay it money is a reputed name, then the banks are willing to give the company loan against the security of these trade/account receivables.
The arrangement works in the following manner. Let us assume that a company has supplied goods for about ₹100 to a Tata Group Company. As per the credit terms, the Tata group company would pay it after 60 days. However, if the company needs money urgently, then the company approaches banks for taking a loan against this money that it would get after 60 days.
As Tata group has a good reputation and the bank would believe that the Tata group company would honour its commitment and pay the money after 60 days. Therefore, it agrees to pay ₹98 to the company against the security of ₹100 that the company is expected to receive from Tata Group Company after 60 days. The company get ₹98 today from the bank and the bank receives ₹100 directly from the Tata group company after 60 days. The bank earns ₹2 in the 60 days on ₹98 that it had loaned to the company. This turns out to be a 12.6% annualised interest income for the bank.
An investor would appreciate that in this arrangement, the company got the money (₹98) immediately after sending the goods to Tata Group Company and the bank has earned 12.6% interest by lending money to the company for 60 days.
This arrangement is called “bill discounting”.
Many times, in such arrangements, the companies who get money from the bank under bill discounting, in the accounting treatment, they show that they have got the money due under receivables on the day 1 when they get the money from bank instead of day 60 when the Tata group company makes the payment. Such a treatment lowers down the amount of their trade/account receivables and in turn, lowers their receivable days.
However, an investor would appreciate that at the end of the day, it is the responsibility of the company to pay the bank if the customer (e.g. Tata Group Company) fails to pay on day 60 or whenever the payment is due. This is because if the bank did not receive the money from the customer then it will initiate recovery proceedings against the company to get its money. Therefore, under “bill discounting”, the company has a contingent liability equal to the amount of trade receivables discounted by it with the banks. If the customer does not pay when the money is due, then the company has to pay the bank.
Therefore, bill discounting effectively converts trade receivables into contingent liabilities. Investors should always keep this aspect and the contingent risk in mind when they assess any company showing lower receivable days by using bill discounting.
Let us see the example of a company that has used bill discounting to lower its receivable days.
i) Nile Ltd:
Nile Ltd is an Indian manufacturer of Lead and its alloys, supplying primarily to battery manufacturer Amara Raja Batteries Ltd.
While analysing Nile Ltd, an investor notices that the company used to have its receivable days in the range of 35-40 days; however, in FY2016 and FY2017, the receivable days suddenly declined to 16 days and 14 days respectively.
While going through the credit rating report of Nile Ltd, published by India Ratings & Research in April 2014 (page 6), an investor would find the reasons for this improvement in the receivables management by the company:
Nile’s working capital cycle improved to 38 days in FY16 from 51 days in FY15. The improvement was due to the management’s decision to increase the use of bill discounting and non-fund based facilities for early realisation of receivables and procurement of raw materials.
India Ratings & Research highlights that Nile Ltd is using bill discounting facilities to get its receivables at an earlier date than scheduled.
Under bill discounting, a company which has sold its product to a good reputed customer goes to a bank and shows the bank the bill showing the acceptance of the goods by the “reputed customer” and the amount, which the “reputed customer” has agreed to pay to the company after agreed amount of days.
The bank takes the comfort of the reputation of the customer and in turn agrees to give the company money against the security of this bill after adjusting for its interest/fee charges. The company gets the money early and the bank receives the repayment of the money given to the company when the “reputed customer” makes the after the agreed number of days.
While analysing the FY2017 annual report of Nile Ltd, page 57, in the contingent liabilities section, an investor notices that Nile Ltd has been making good use of bill discounting facilities and at March 31, 2017, it has discounted bill of about ₹50 cr. (₹5.2 cr. with a letter of credit (LC) and ₹45 cr. without LC):
Guarantees and letters of credit:
(a) Bank Guarantees issued by Bankers – Rs.15.00 Lakhs (Previous year – Rs.29.24 Lakhs)
(b) Letters of Credit issued by Bankers – Rs.1,329.21 Lakhs (Previous year – Rs.452.97 Lakhs)
(c) Customers bills discounted with Banks backed by LC – Rs.520.19 Lakhs (Previous year Rs 633.62 Lakhs)
(d) Customers bills discounted with Banks – Rs.4,507.24 Lakhs (Previous Year Rs.5,904.16 Lakhs)
It is to be noted that the trade receivables outstanding at March 31, 2017, as per FY2017 annual report are about ₹29 cr.
Simply, an investor may understand it assuming that Nile Ltd had total trade receivables of about ₹79 cr. at March 31, 2017, out of which it got an early payment of ₹50 cr. by discounting the bills of “reputed customers”, which mostly are expected to be Amara Raja Batteries Ltd, from the bank and therefore it showed remaining ₹29 cr. as to be collected.
The investor would also notice that in case the “reputed customer” does not pay the money on the agreed date due to any reason, then the bank will ask its money back from Nile Ltd. This is the reason that the money received by Nile Ltd from bill discounting is shown under contingent liabilities.
An investor may read our complete analysis of Nile Ltd in the following article: Analysis: Nile Ltd
Therefore, an investor would appreciate that she should always read the contingent liability section of the annual report for every company so that she may get to know the actual financial position of the company.
Until now, we have seen business cases where the receivable days of a company tend to be low or high. These cases related to the negotiating power held by the company over its customers, the kind of business like project work done by the company, nature of business like selling through distributors or directly to end-customers, customer concentration etc.
Let us now focus on another aspect that may lead to an increase in trade receivables and receivable days, which is accounting juggleries or frauds.
D) Accounting juggleries or frauds leading to a high receivable days:
Whenever an investor notices a company that have abnormally high account receivables, and receivable days to an extent that the company is not able to convert its profits into cash flow from operations, then she should become cautious and increase the depth of her analysis to understand why the company is not able to collect its dues from the customers. This is because if the sales reported by the company are fictitious, and the customers are not real, then the company may never receive the money due from the sales.
In such cases of corporate frauds, where the management fabricates the sales to present a good profit and loss (P&L) statement, the first red flag that an investor may see is that the profits are not collected as cash. Therefore, the sales get accumulated as trade receivables and as a result, cash flow from operating activities lags its net profits.
In such instances, continuously increasing receivable days acts as the first sign that indicates the need for deeper due diligence by the investor.
An investor may read the following article to understand more about detecting accounting frauds: 7 Signs to tell whether a Company is cooking its Books: “Financial Shenanigans”
With this, we have come to the end of the current article in which we have attempted to summarise our learning from the analysis of hundreds of companies and their businesses. We had noticed that there are some common factors in the business model of companies that determine whether the company would have high receivable days (more than 60 days) or low receivable days (less than 30).
During our analysis of companies, we found that in the following situations, usually, companies have high receivable days:
- Companies that sell commoditized products and have very low negotiating power over customers
- Companies doing project work where payments are linked to the achievement of milestones
- Companies that work for govt. agencies
- Companies with a concentration of customers
On the contrary, the companies with the following characteristics have low receivable days:
- Companies with a strong pricing power over their customers
- Companies that sell directly to end-customer and thereby, cut-down supply chain intermediaries
We have noticed that many times, companies who sell to reputed customers are able to discount their receivables with banks in a process called bill discounting. Thereby, the companies report lower receivable days. However, even after bill discounting, the risk of customer default lies with the company as the bank will recover its money from the company. Therefore, in bill discounting, companies show a contingent liability equal to the amount of receivables discounted by them. An investor should read the contingent liabilities section of the annual report for all the companies before making her opinion.
In addition, another reason for high receivable days is accounting fraud where companies may have reported fictitious sales where the customers are not real. In such cases, the P&L statement shows good profits but the cash flow statement does not show commensurate cash flow from operations. As a result, rising receivable days may represent an initial sign to uncover underlying frauds.
Now, it is your turn to let us know how you use receivable days in the analysis of companies. Have you found that receivable days help in differentiating between companies? What are your experiences and your recommendations to other investors? You may share your inputs in the comments section below. Your inputs will be highly useful for the author as well as other readers.
Dr Vijay Malik
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Registration status with SEBI:
I am registered with SEBI as a research analyst.
Details of financial interest in the Subject Company:
I do not own stocks of the companies mentioned above in my portfolio at the date of writing this article.