Dear Friends,

Please do not invest in debt free companies!

Have you ever heard of this title and wondered why?

Please do not be alarmed upon seeing the title.

Just continue reading, and the true meaning behind it will become clear to you on this aspect.

Whenever the topic of stock market investment comes,  the first piece of advice we often hear from many sources, seniors and peers is that "Invest only in companies that are free of debt."

While this is generally a sound advice, there are certain instances where the presence of debt can actually be beneficial for a company also.

In this post, we are going to explore one such "beneficial debt" metric known as "Days Payable."

Some companies operating in the stock market generate substantial profits simply by delaying the repayment of debts they owe to others.

"Taking on debt is not inherently wrong; rather, a company's true financial acumen lies in when and how it chooses to repay that debt. This is the major aspect and we need to learn more on this and to see this in their financials as well.

"Days Payable" is a metric that indicates how long a company delays making payments to its suppliers. That is, the vendors who have provided goods to the company.

This specific parameter which many investors often overlook, can effectively reveal the extent of a company's "Market Power."

Let us examine some of the underlying truths hidden behind the "Days Payable" figure found within a company's financial records. We can illustrate this concept using an example involving two different retail shops.

First, let us take a shop by name "A Stores." The proprietor of this shop is a small-scale retailer and runs a modest grocery store right here on our street end. He approaches a large wholesale supplier and requests to purchase the essential grocery provisions worth 10000 $ on credit. However, the supplier strictly responds, "I will hand over the goods only if you pay in cash." Having left with no other alternatives, our friend at "A Stores" immediately pays the full amount in cash to acquire the supplies that is necessary for his shop to run and get the customers. Currently, the "Days Payable" for our "A Stores" stands at 0 as he has already paid everything and nothing comes for him in credit.

Next, let's take at "B Mart," a large supermarket in our town. The owner approaches the wholesale supplier and sets a condition: "I will stock your goods in my store, but I will only pay you 90 days after they have been sold." The wholesale supplier agrees to this kind of mechanism and supplied the requested grocery essentials worth 10000 $ to "B Mart" on a 90-day credit term period. Now "B Mart's" Days Payable now stands at 90.

If we compare these two stores to see which one enjoys greater cash flow, the answer is undoubtedly "B Mart." This is because "B Mart" retains the 10000 $ it owes to its supplier in its own hands for a full 90 days. "B Mart" can take this idle cash which it is simply holding and can invest it in another business venture, use it to further expand its own operations, or deposit it in a bank to earn interest.

This widely popular and clever strategy of conducting business using other people's money is known as the "Days Payable Technique." It is also referred to as "Negative Working Capital."

Simply put, "Days Payable" represents the average number of days a company takes to repay those who have supplied it with goods or services (its creditors or suppliers). When observing this metric within corporate entities, a high Days Payable figure indicates that the company possesses significant market demand and strong bargaining power.

One can interpret this as the company effectively saying, "I will pay you late; supply the goods only if you are willing to accept that." If suppliers—having no other viable alternative—continue to supply goods under these terms, it signifies that the company holds a monopoly position or is a major, established brand.

However, there are several key factors within this context that must also be carefully considered. While I previously mentioned that a high "Days Payable" figure is generally a positive sign, this is not universally true. This is precisely where one must exercise extreme caution. This situation can turn dangerous under the following circumstances:

1) Suppose a company lacks sufficient cash on hand and, seeing no other alternative, continuously delays payments owed to its suppliers. Consequently, the suppliers may become irate and cease supplying goods to that company. Such an action would adversely impact the company's sales posing a significant threat to the business.

2) If a company consistently drags out payments for purchased goods to its suppliers over a prolonged period—say, 200 to 300 days—it signals that there is a fundamental flaw within the company's management. Therefore, instead of focusing solely on "Days Payable," one can achieve superior results by analyzing this metric through the lens of "Smart Money" strategies, as outlined below.

Major investors (often referred to as "Smart Money") analyze a company by examining three key metrics in conjunction: Days Inventory, Days Receivable, and Days Payable.

1) The company sells its inventory rapidly; in other words, it maintains a low "Days Inventory" count.

2) It collects payments for sold goods from its customers swiftly; that is, it maintains a low "Days Receivable" count.

3) However, it deliberately delays payments owed to the suppliers who provided the goods—resulting in a high "Days Payable" count. When a company exhibits this specific ratio, it indicates that it is being managed with exceptional efficiency.

Essentially, the company accelerates the collection of funds owed to it while strategically deferring the payments it owes to others.

As a result, the company eliminates the need to borrow funds from external sources. This creates a unique opportunity for them to leverage the cash currently on hand to multiply their business growth manifold.

It’s like this: when a company collects its dues, it’s a '20-20 match'... is it?

Happy investing and have a great time in the markets!