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ASSESSING A COMPANY’S FINANCIAL STRENGTH
Net Cash
Net Cash = Cash – Borrowings
Cash includes bank balances, deposits, cash and Money Market Instruments (which may be reported as "Short Term Investments" by some companies - eg Genting) but excludes Cash held under Housing Development Accounts in the case of companies which are involved in property development.
Borrowings comprise of interest bearing debt and include hire purchase debt, finance leases, subordinated loans and unsecured loan stocks such as ICULS.
By looking at Net Cash or Net Borrowings, we have an idea of:
- whether the company is in debt after taking into account its cash holdings, or
- whether the company is in a cash position after taking into account its borrowings
Quite often, media reports would cite a company as having billions of ringgit in cash, however this in itself is meaningless as it does not cite the company’s borrowing position. A company may well have RM1 billion in cash but at the same time has RM5 billion in borrowings. So it is important to look at the overall position including other assets owned by the company as well, to get a good feel for the company’s financial strength and its ability to expand or make acquisitions.
Gearing
Gearing = Net Borrowings / Net Assets
Interest Cover
Interest cover is a company’s EBIT divided by its Net Interest Expense. For example take a company has EBIT of RM100 million per year. Let’s say its Interest Income is RM3 million while Interest Expense is RM13 million. That means its Net Interest Expense is RM10 million. Therefore Interest Cover is 10 times.
This is a good indicator of the company’s ability to service its debts. If Interest Cover is too low, then a company could find it difficult to service its loans if earnings take a small dip.
To apply this concept, just think in terms of how much salary you earn (before tax) and how much interest you pay the bank on your loans (eg housing loan & car loan). Say you earn RM10,000 per month and the interest element on your loans total RM2,000. Your Interest Cover is 5 times and it is still quite comfortable.
But say you are only earning RM2,000 per month and your interest expense is RM1,000, your Interest Cover is only 2 times and this is obviously not a very comfortable position to be in.
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