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A company is said to have “net cash” if it has enough cash on hand to pay off all its debts. The net cash figure is the amount by which its cash balances exceed its total debt. If, on the other hand, its debts exceed its cash resources, the company is said to have net debt equal to the amount by which debts exceed cash.
As ever there are complications, in this case because financial analysts have come up with more than one way to define net cash (or net debt). We will use a figure that is relatively easy to work out and, perhaps more importantly, is readily available online to those who prefer to ditch the calculator and just look up the number.
“Cash” is usually understood to mean money held in a company’s bank accounts, plus the value of any assets that are effectively cash, such as gilts (British government bonds) close to their maturity date. There are some subtleties about what exactly counts as “debt” and analysts and fund managers may use their own definitions.
In this article we will include in our “debt” figure a company’s long-term borrowings (such as bonds it has issued) and certain short-term borrowings, such as short-term lease obligations. A company’s balance sheet, available in its annual report, will make clear which of its liabilities are short term and which are long term.
How do you calculate a company’s net cash or net debt figure?
First of all, if you want to avoid the headache of calculating the figure you can look it up online. One source is morningstar.co.uk: type the name or stock market “ticker symbol” of the company in which you are interested into the search box then click on “Financials & Ratios”, then on “Balance Sheet”, where you will find a figure for “Net Borrowings”. A negative figure means that the company has net cash.
If you want to do the work yourself, either download the company’s annual report or visit its page on Morningstar or fidelity.co.uk, where you can find the figures you need for cash, long-term borrowings and any short-term borrowings we need to include.
Worked example
We will use Cranswick (ticker symbol: CWK), the food producer, as an example – not least because it has nice “clean” accounts without many complications.
If you download its most recent annual report, you’ll find its balance sheet on page 148. Under the heading “Current assets” you’ll see “Cash and short-term deposits” of £27m. The first item to subtract from this is the total of long-term debts, which are listed on Cranswick’s balance sheet under the heading “Non-current liabilities”. The total is given as £141.1m. However, we are going to exclude a couple of items.
You may be wondering how we decide what to include and what to exclude. Unfortunately, there are no hard-and-fast rules and different analysts may have their own preferences, but one rule of thumb is to exclude liabilities that do not incur interest. Among the non-current liabilities that Cranswick lists, three fall into this category: “Deferred tax liabilities” of £28.4m (the tax is not yet due so no interest is charged); “Provisions” of £2.6m (provisions are sums notionally set aside to meet a potential liability); and “Other payables” of £0.9m.
When these three items are excluded, long-term liabilities come to £109.2m. Among short-term liabilities we’ll include only lease liabilities of £17.3m. If we add that figure to the long-term debts we get a total of all liabilities of £126.5m.
We should note in passing that all these liability figures appear on the balance sheet in brackets. This is how negative numbers are presented in financial statements.
If we subtract that £126.5m from the cash balance of £27m we arrive at net debt of £99.5m.
To illustrate just how common it is for different people to use different ways to cut the numbers, Cranswick itself states a net debt figure of £99.4m on page 183 of its annual report, while Morningstar puts the figure at £100.4m. In view of all the possible points of difference, these three figures are close enough to each other. Alternatively, we can simply round them to £100m.
How to use the net cash or net debt figure
The use of the net cash or net debt figure is subtle: it’s not as simple as saying that having net cash is good and having net debt is bad. It depends on the type of company involved and various outside circumstances.
What we can say is that a company that has net cash is, all else being equal, better protected from unexpected setbacks or changes in economic circumstances than one that has net debt. Holding cash can, however, come at a cost. Cash may earn interest but it is otherwise not being put to use as it might if used to invest in productive assets for the company. This is especially the case when interest rates are low, as they were until recently.
This may be a price worth paying for certain types of company, such as those that experience wide fluctuations in demand for their products – a cash balance can see them through the lean times whereas debt that has to be serviced irrespective of the company’s income could be a serious millstone.
The other side of that argument is that a stable, non-cyclical business can afford to carry debt because it knows that the income to meet interest payments will arrive no matter what. Utilities are often put into this category.
When interest rates were near zero they were in the enviable position of being able to fund themselves with other people’s money at virtually no cost. As has been widely reported, however, some of them found themselves severely exposed when interest rates rose. It’s always worth bearing this possibility in mind when you assess a company’s debt position.
Analysts often judge the sustainability of a company’s debts by comparing them with profits, very often on the “Ebitda” measure (earnings before interest, tax, depreciation and amortisation – amortisation is simply depreciation when it concerns intangible assets).
In view of what we have said above, the appropriate level of the “debt-to-Ebitda” ratio depends on the type of business we are dealing with. However, professional investors will often become uneasy once debt exceeds three times Ebitda. But when you are analysing an individual stock it may be more useful to compare its debt-to-Ebitda ratio with those of its direct rivals.
You can calculate the ratio by looking up the two numbers at Morningstar (click on “Financials & Ratios” for the stock you want; you’ll find Ebitda under “Income Statement” and net borrowings under “Balance Sheet”).
Richard Evans is an investment writer at Fidelity International
