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There are five areas to consider when identifying whether or not the company has sufficient cash:
- Repayment of existing loans
- Increase in working capital
- Capital expenditure requirements
- Contingent liabilities
- Leasing commitments
All loans to be repaid in the next couple of years should be considered, including any convertible loans if the conversion rights
are unlikely to be exercised.
If the business is expanding, working capital will also need to increase.
The note to the financial statements may disclose capital expenditure contracted for. It’s necessary to consider whether the company will have sufficient cash to meet this capital expenditure.
Most contingent liabilities do not crystallise, but if these liabilities are very high their crystallisation could real problems for the company. Some analysts compare the contingent liabilities with total shareholders’ funds to assess the materiality of those commitments. Any sharp increases in the amounts involved should act as a warning.
If these are material, they should be carefully monitored in relation to the cash available. The financial statements should disclose both finance lease commitments (for new leases where repayments have not commenced) and also operating lease commitments.
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