Companies that don’t have enough readily-available cash to deal with short-term spending requirements can find themselves at the heart of a liquidity crisis.
Businesses which suffer such a crisis in their immediate funding might have to return to the market for extra cash, or take out a short-term loan with a bank (likely at a high interest rate). When combined with solvency (long-term financing) problems, businesses with liquidity issues are in danger of bankruptcy. Investors who want to avoid companies which rely on regular funding boosters should keep a close eye on liquidity.
This article aims to help investors identify companies at risk of short-term financial disaster. We’ll start by providing an overview of the basic checks investors can make to ensure they aren’t investing in poorly-funded companies, before taking a look at advanced analysis techniques for more experienced investors.
Cash is king
Cash is the ultimate liquid asset. When it is sensibly deployed it can be used to generate more cash, which can subsequently be invested. And so the virtuous circle continues.
But a company’s net cash position needs to be assessed in context. How does it compare to last year? Where has the cash come from (has there been a recent fundraising or is it internally generated)? How does it compare to cash burn?
Take healthcare company Bioventix (LON:BVXP) which is currently sitting on £6m of net cash without any reliance on external funding. The company has very low spending requirements and generates impressive cash profits from its product portfolio. The cash inflows easily cover all of the company’s investment requirements and have supported a healthy dividend.
By contrast, OptiBiotix Health (LON:OPTI) (a peer in the small-cap healthcare market) is repeatedly forced back to the market to top up its cash position. In the financial year to December 2021 the company burned through £1.5m of cash through its operations and then invested a further £200,000 on capital expenditure. By the end of the year it had less than £1m of cash on its balance sheet. When cash burn is greater than the net cash position, the company has a problem. No surprise, Optibiotix was forced to return to the stock market for more funds in 2022.
For larger companies, a better assessment of the cash position can be done using…
