Watch out for the following warning signs:
- Cash-rich with extremely low deposit rates.
If the company’s cash yield is significantly lower than bank deposit rates and government bond yields, it could indicate a possibility of fraud or embezzlement.
- Cash-rich with low dividend payout or no dividends
If the company has huge amounts of excess cash not needed for operating or investing needs, it should return the cash to shareholders. It is a sign that the cash is not there.
- Cash-rich with high leverage
If a company has large amounts of cash at hand, it should reduce financial distress risk and interest expense burden by repaying the debt. The cash on the books could be non-existent.
- Cash-rich and doing more fund raising
Companies which frequently raise capital or borrow are at the mercy of capital markets. It is likely that a Ponzi scheme could be at work, with companies seeking fresh capital to fund “fake cash.”
- Cash-rich with long cash conversion cycle
Cash conversion cycle (inventory days plus receivable days minus payable days) is more than 90 days.
The cash cycle is a reflection of how long it takes a company to get paid for its cash outlay in running the business. If a company has sufficient cash, it should not be paying trade creditors late or having trouble collecting cash from trade debtors.
As usual, caveat emptor. When it is too good to be true, check again to be sure.