TABLE OF CONTENTS We have already established that profit and cash are two completely separate issues, and when a financial institution is considering lending money to a company its most important consideration is the ability to pay.
This does not mean that the ratios considered so far are obsolete as the bank will want to confirm that its customer has a viable business, but it does infer that some additional indicators with an emphasis exclusively on cash are required. The significance of cash has long been recognized and more than 40 years ago W.H. Beaver showed that comparing cash flows to total debt was a strong indicator of potential corporate failure.
Rather confusingly it is usual for the cash flows from operations to include the proceeds arising from the disposal of long-term assets.
This ratio shows the rate at which a company recovers its investment in assets with a faster recovery rate implying lower risk. As with all cash-based ratios this is more difficult for a creative finance director to manipulate as cash balances are a factual number easily validated by reference to a bank statement.
It is vital that...
