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Highly cash rich company. Good or bad?

Net cash company. Good or bad?


Since young, I have been taught that having debt is a bad thing. Having debt means that you are trying to buy something or do something that is out of your range. Having debt is bad. As the Chinese saying goes, 无债一身轻, I believe many investors, especially Asian or Chinese in particular, has been raised in such a way. They are afraid of taking debt, and will subconsciously define things related to debt as bad thing.

However, is this a right concept? Not really. Debt, is actually a powerful tool for us to grow in value if we use it wisely. The same goes to company.

Generally, let's divide the business style of a company into two categories: progressive and conservative.  

i. Progressive company

Normally, a company that has high debt is an progressive and aggressive company. They seize on opportunity and believe that the market today is dynamic. Their concept is that to keep up with the pace with the market, one have to continuously improve and revise their company direction. As a result, the company is keen on expanding their business and enter new market.  To do this, a company might need to take loan from the bank, resulting in high debt. (Not necessarily bad)


ii. Conservative company

A company that is conservative will normally has free cash, and has no debt at all. Although this shows a very healthy financial position, the company is normally taking a more defensive move in the market. The management are contented with their current business position and has no or less intention to expand it. They do not like to take on risk, and do not bother to take loan in venturing into new business or market. Unless the product of such company is irreplaceable, the company will surely be eliminated from the game soon.

On the other hand, an excessively high cash reserve also indicates that the company are having excess cash but has no place to invest. Let me ask you a question. Why do you invest in stock? Why? I am sure that your answer would be "Fixed deposit give me so little money, inflation also higher than it lo! Stock investment can earn more ma!" Something similar right?

Imagine now company A earns a net profit of RM1 million annually for the past 10 years. However, for the past 10 years, Company A never use this free cash flow and never expand their business. What will happen? In that case, up to date, the net profit is still stuck at RM1 million. It will never increase as no expansion of business is done. Furthermore, the accumulated RM10 million will only get  a very low ROR (probably lower than fixed deposit rate) because the management did not invest them wisely. Even inflation could be higher than that! So think again, is a high cash reserve company really good? No. Having excessive net cash flow means that the management fails. They are incapable of producing higher ROR for their shareholder, for you and for me. Moreover, most probably the company's revenue will not grow significantly and will only remain at that contented level.

Striking a balance between debt and positive cash reserve is the key. 

In my opinion, I think that a good company should have both positive cash reserve and debt. Loans from bank should be used wisely to invest on projects with high rate of return. Meanwhile, a company should also have positive cash reserve to allow turnover. As long as the rate of return for project is high enough to cover debt's interest rate, a company should go for it. Expand and grow the company.

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