What cash ratios of companies tell you about their financial health – remember to study this when investing….

Cash is King – that’s a motherhood statement. It is more important to study the cash ratios of companies when investing. Here are some aspects of cash to consider when studying the financial health of a company…

First, when a company is holding on to too much cash, it does not always mean that it is a good company. If the cash is not used to generate growth for the company but simply earning fixed deposit interest, it shows that the company’s management is not using its cash well to generate income to realise the full potential for the company. Hence, there ought to be good reasons for a company to keep its cash eg. having some planned investment or planned dividends as it rides out some challenging quarters ahead. Otherwise, it would be better off to return them to the shareholders.

Secondly, if a company’s cash ratio is 1, it means it has just sufficient cash to meet its liabilities. The higher this ratio is, the safer the company. If the cash per share is higher than the price of the share price, it represents good value for the investor. Check of this article that provides a list of companies on the SGX where the net cash exceeds the market capitalisation of the company (ie. cash per share is higher than the share price.) But remember, it is always necessary to assess a company holistically and not just by its cash ratio. There is always a reason why a company’s shares appear to be at “bargain prices”.

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