Reader questions: Dealing with cash
Today's Financial News - Posted December 9, 2008
Smart investors are asking lots of questions. Before putting their money on the line, they want to know all they can about a company. I love this reader’s question about cash reserves.
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): In times like these it pays to be an intuitive and astute investor. Instead of holding your nose and jumping blinding into the markets, cash in hand, successful investors are treading lightly and asking lots of questions along the way.
I love it when a reader emails me with a question that proves he is using his brain instead of his heart when it comes to investment decisions. Over the weekend, a TFN reader sent me the following email:
I am just wondering how one would go about determining if a company is cash heavy? I know I can look at a balance sheet on yahoo.com, but that only provides a number. I am not an analyst so I need a simplified way to determine how much cash is “cash heavy”.
This is a great question. Understanding the answer can lead to a much better shot at profit potential. Let’s take a look at what Yahoo Finance has to say about two popular companies, General Motors (NYSE:GM) and Microsoft (NASDAQ:MSFT).
According to the site, GM had $19.5 billion at the time of its last quarterly report (Yahoo lists the company’s second quarter). Microsoft, on the other hand, had just $9 billion in cash (during its third quarter). Our savvy reader is smart to realize those figures are just numbers. The devil will lie in the details.
It is all relative
To figure out which company truly is the stronger of the two, we have to dig much deeper. The cash figures listed in the quarterly report are a mere snapshot of the cash available on the day the report was compiled. Today’s figures are likely drastically different.
What we really need to know is if the company is adding to it cash position or drawing from it. And most importantly, if the cash is enough to pay the electric bill each month.
Imagine your monthly bank statement. By the time you get it in the mail, it is already out of date. It may show that you have $3,000 in your checking account, but if you already made a $1,800 mortgage payment, a $500 car payment and your wife secretly bought a $700 designer purse, that account is down to nothing. If your income during that same period was not higher than your expenditures, you are in trouble.
It is no different in the world of business. That means we have to look at a company’s cash flow to get a glimpse of wear its cash reserves are headed.
Fortunately, Yahoo can give us all of the information we need. Simply click on the “cash flow” section and all the figures you need are right there. For novice investors, there are a lot of complicated-looking account entries on the page. Fortunately, all the information you really need to know is listed at the top and bottom of the page in big, bold numbers.
Where did it all go?
As for GM, the site reports the most recently reported net loss was $15 billion. Fortunately, not all of that loss will come out of the company’s cash reserves. Once the accountants have their way with the books, just $2 billion is pulled from cash. Even so, that figure represents almost 15% of the company’s total reserves.
As we know, the situation in Detroit is getting worse by the day. These figures are miniscule in comparison to the cash burn the company is currently reporting in Washington.
Now, let’s look at Microsoft’s cash flows. During the third quarter of this year, the software giant’s net earnings were $17.7 billion. At the bottom of its cash-flow statement, we can see that $4.2 billion of that profit flowed into the company’s cash account.
While GM is burning through piles of cash, Microsoft is adding to its position. Even though the software company looks like it has a smaller cash position, its horde is much, much healthier than the automaker’s stash.
Keeping up with the bills
Cash flows are only one way to measure a company’s cash position. Another technique is to compare its liquid reserves to its short-term debt. We call this measuring the company’s current ratio, as it is an indicator of its ability to pay its “current” bills.
To find the number, simply divide a firm’s liquid cash position by its short-term (less than 12 months) debt. The higher the number, the stronger the company’s ability to pay its bills.
Yahoo lists GM’s current ratio at 0.73 (I believe it is actually much lower). That means for every dollar of debt due over the next year, the company has just $0.73 in cash available to pay it off. Microsoft’s figure of 1.5 means the company has $1.50 in cash available for every dollar it owes. Which company would you rather be an owner of?
When we started, GM looked like the stronger company, as its cash reserves were more than $10 billion stronger than Microsoft’s position. But after looking at some very basic financial figures, we quickly deduced GM is in serious trouble while Microsoft has few financial worries in sight.
Our reader was right; a cash position is merely an arbitrary figure. Hopefully, now he knows how to use that figure in ways that can tell him much of all he needs to know about a company’s financial situation. Keep the questions flowing.
Next Article: Illinois attempts to blackmail Bank of America (NYSE:BAC)
Be the first to leave a reply.
Your comments are welcome
Follow TFN via RSS or Twitter |
 |
 |
 |
Advertisement
Latest Headlines
- The Big Picture for Sinobiopharma, Inc. (SNBP)
- Beazer Homes USA, Inc. (BZH) and Hovnanian Enterprises, Inc. (HOV) up despite horrid housing news
- The FDA catalyst: 2010 moves in MannKind (MNKD), Roche Holding (RHHBY), Acorda Therapeutics (ACOR) show it still works!
- Steepest drop since Feb. 2009: Here we go again!
- Is the silver run over? Coeur d’Alene Mines (CDE), Silver Wheaton (SLW), Alto Group (ALTO), Hecla Mining (HL), Endeavour Silver (EXK) close down