In Focus

Cash To Long-Term Debt

Note: This article focuses on Step 8 of the Chicks' Dozen. For articles focusing on other Steps, see the links listed at the bottom of the page.

I'm still at the Lone Star Ranch in Stettler, Alberta, Canada. I'm the chaperone on a three-day field trip for my daughter's school. I am spending more time in my car trying to warm up than I am really chaperoning. It's snowing and I'm freeeeeezing. Sheeez, last week I was in Hot-lanta, Georgia with 100-degree temps and this week, flurries in the Great White North. Can't I ever just be in Kansas? (Don't answer that, smartie pants.)

Speaking of Kansas, today I'd like to talk a little bit about the Wizard of Oz and Cash to Long-Term Debt. Just wait, the analogy will make sense. Yesterday I talked about how the Chicks would like their company's net margins or net profits to be more than 8%. Today I'd like to focus on what a company does with that profit. Where do we like a company to be putting that extra cashola? Also, why do we think it is important for a company to have a lot of cash, at least as much cash as they do long-term-debt? Enter... Wicked Witches.

Let's pretend the Wicked Witch of the East and the Wicked Witch of the West each have their own soup companies. One is called West Witch, Inc. and the other East Witch, Inc. (Both sound like made for TV Movies, don'tcha think?) West Witch has been methodically concocting her brew for the past 100 years. It consists of rabbits' feet, snail innards, chicken bouillon and a dash of ruby slipper. She has been marketing it through specialty grocery stores for years under the label Glenda's Gourmet Gumbo®. She has consistently put every penny of profit into a money market account that earns interest. She now has $184,000,000 in the account.

Now, her sister on the other side of the world also has a soup business, called Witches of East Bisque®. She flies by the seat of her pants. One day she'll make up 4,000 cans of consommé, ship them out to Superstores across the country, collect her money, and then take a vacation in Alberta, Canada. (Crazy witch.) She has no real plan... just makes soup when she needs money. She spends every ounce of profit, either paying overdue bills or flying about the country in search of the Yellow Brick Road. Her cash balance right now is zero.

Now one day (picture it), a tornado hits. Everything is wiped out on both ends of the Witches World. West Witch has her rabbit farm destroyed and East Witch has lost her recipe. The one thing that they didn't lose was their debt. They both have $100,000 in long term debt. Yikes! But this isn't a problem for West Witch. She has enough cash in her money market account that the debt can be paid off easily. She continues, life as normal, and buys some more rabbits. East Witch is freakin'. She has nothing to fall back on. No place to live, no cash in the bank, and no pot to pee in, I mean, stew in.

If you were an investor, which of the two companies would you rather have stock in? East or West? Wouldn't you want to invest in a business that had a lot of cash? Doesn't it just make sense that you'd want a company that was financially responsible and prepared if things went haywire? Just think about it. If you had invested in East Witch, Inc. and didn't keep an eye on her Balance Sheet, you wouldn't have had any inkling that she was going to fall flat on her face. But if you had kept an eye on her sister's Balance Sheet, and the Cash to Long-Term Debt ratio, you would know that West Witch, Inc. would be able to survive a slump. She had enough cash in the bank to pay off her long-term debt. She had 1,840 times more cash than long-term debt. Here is how I figured that:

184,000,000 (Cash in Money Market) / $100,000 (Long-term debt) = 1,673

West Witch, Inc. would be the better place of the two to keep your money.

The Chicks look for companies that don't carry a lot of long-term debt, and if they do, they have enough cash to cover it. The Cash and the Long Term Debt figures for a company you are researching are found on the Balance Sheet. Take the Cash and divide it by the Long Term Debt. If the answer turns out to be 1.0 or greater, then they meet the Chick's Dozen Step Seven. The larger this number, the more Cash to Long-Term Debt it has. This is good. Big numbers are good. The Chicks would like the companies that we invest in to have enough cash on hand to pay off their Long-Term debt (if they had to).

If the number turns out to be lower than 1.0, remember one thing... "I'll get you my Pretty!"

Wishing I were in Kansas,

Chick Karin

Articles focusing on the 12 Steps of the Chicks' Dozen:

Step 1: Buy What You Know

Step 2: Keep It Simple, Sister (K.I.S.S.)

Step 3: Industry

Step 4: Leader In It's Field

Step 5: Repeat Profitability

Step 6: Gross Margins, GM: Service Related Industries

Step 7: Net Margins

Step 8: Cash To Long-Term Debt

Step 9: Flow Ratio

Step 10: Increasing Growth

Step 11: Strong Management & Operating History

Step 12: Buy On Sale