One of the surest ways to determine the health of a company is to take a peek at the cash flow statement. Positive cash flow indicates that a company’s liquid assets are increasing, which means the company has a buffer against challenges down the road. Beyond that it signifies that the company can engage in all sorts of pro-business actions—paying down debt, reinvesting in the business and returning money to shareholders, for instance.
But is there ever a time when an abundant reservoir should concern potential investors? A recent study from Singapore Management University (SMU) School of Accountancy found that firms with poor governance generally prefer to hold more cash. Issues around governance are more likely to occur at firms with steep hierarchal structures; that are controlled by families; and where one person acts as CEO and chairman. Companies with these attributes can be a magnet for internal dysfunction, the study’s author, Professor Yuanto Kusnadi. (The study itself only surveyed firms in Malaysia and Singapore.)
Managers at these firms had “more discretion over corporate cash policies,” and therefore reserves were more susceptible to expropriation by insiders. The controlling owners are typically family members who often also hold senior management positions. The firms in question had little incentive to distribute any excess cash to minority shareholders.
Hoarding cash also generates low returns. “The value of most businesses,” the study says, “is secured within things that generate income, such as buildings, machines and wages.” Word to the wise: when evaluating companies, take a closer look at the miserly ones.
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