1 Foolish Ratio to Find Companies Gushing With Cash

Cash is the lifeblood of companies. Without cash flowing through its coffers, even a company with great sales reports might not survive in the long run.

Today, I would like to introduce one financial ratio that might capture the essence of how much cash is flowing through a company and whether that company is able to keep more of it.

With the ratio, we can find companies that are gushing with cash and they can in turn be investment candidates worth studying

The Foolish Flow Ratio

To introduce the Foolish Flow Ratio, I turn to the Motley Fool’s Chief Executive Officer Tom Gardner. Tom shared his thoughts on this ratio in the Fool’s own book Rule Breakers, Rule Makers:

“Naturally, when we search for rule-making companies, we’d like them to make the best use of the money that flows through their business. As investors, we need to monitor those tides coming in and going out, because businesses survive on their cash.

In ideal circumstances, a business will bring money in quickly, like the continuous rush of a waterfall, but pay it out slowly, like water drips from an old sink.”

In essence, Tom prefers to look for companies which are able to bring in gushes of cash while paying it out slowly on the other end. To capture this dynamic, Tom looks at three major elements in a company’s balance sheet: current assets, all cash, and current liabilities.

These three figures are used to form the Foolish Flow Ratio as seen below:

Foolish Flow Ratio

Tom sees cash as the only real asset. Unsold products and uncollected bills (current assets) are deemed to be weaknesses. (Remember that we are trying to find companies which have real cash flowing in and less cash flowing out.)

With that in mind, having more current liabilities (seen as a company holding off on payments) is a better thing – provided, that is, there is enough cash to cover for it.

Taking it all together, if the ratio is below 1, it could be a positive sign.

Test driving the ratio

Let’s use three local companies as examples on how the ratio can work. They are namely, vehicle inspection unit Vicom Limited (SGX: V01), supermarket operator Sheng Siong Group Ltd  (SGX: OV8), and retailer F J Benjamin Holdings Ltd (SGX: F10).

I have summarised the three shares’ current assets, cash, current liabilities, and Foolish Flow Ratios in the table below:

Foolish flow ratio

Source: Companies’ latest earnings report

As you can see, both Vicom and Sheng Siong have strong Foolish Flow Ratios of below 1 due to their large cash positions on their balance sheets.

F J Benjamin, on the other hand, did less good. It had little cash to show with most of its current assets tied up in inventory (unsold goods).

Foolish take away

The Foolish Flow ratio is one way to think about your investments. To be sure, there is no single ratio that can define the future winners in the stock market.

We may also want to see a company have a repeatable business that earns heathy gross margins and net margins. If the company has amassed a large cash position on its balance sheet, it gets better.

When we have all the ducks lined up, we have one final question to ask ourselves. And, that question will be the topic of my next article.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Vicom.