Acceptable Cash Ratio > High ROE
Updated: Aug 14
When I look for good companies to invest in. One of the important factors that I look for is the company's cash flow. How much cash does the company have on hand? Is the company cash flow positive? Why? Because at the end of the day the company can have high ROE, high-profit margins but if they don't have enough cash on hand, then they have already lost the ability to operate.
Cash presents the ability of the company to be opened for business tomorrow. Without enough cash, there is no need to think about the future, because you have lost the ability to pay for your operation expenses. Will employee work for credit payment? Will the bank accept late debt payment? Will your landlord continue to rent for promised payment?
How much cash does the company has?
It is important to look into the future potential of the company. Does the company has the potential to grow and profit in the future is important. However, it is even more important to assess the company's ability to exist tomorrow. If the company can't survive through this year, what is the meaning to assess its potentials for the next 10 years? In fact many potential SMEs have gone out of business not because of their lack of innovation, not that their product sucks, not because their key staff have left. Merely, because they have ran out of cash!
Having an acceptable cash on hand its important. Please note that I have mentioned "acceptable", not "as much as possible". Too less cash puts the company in high operational risk. However, too much cash can mean that the company is not investing enough into the future. I tend to look for company that has a cash ratio around 2 (Cash ratio = cash / short term liabilities). There are people that are fine with cash ratio in the range of 0.5 to 1. However, I tend to take on less risk in my investments therefore I look for higher cash ratio of 2. Depending on your investment habits and the amount of risk that you are able to take on, the cash ratio that you look for will vary. However, I do not recommend companies with cash ratio that are less than 0.5.
Is the company cash flow positive?