As you know, there is no such thing as a “risk free” share market investment.  Some shares, however, are safer than others.  Companies in good financial health are better able to withstand economic calamites than those who are not.

Many experts consider the Cash Flow Ratios we are going to look at as some of the best indicators you can find regarding a company’s financial health.  Even retail investors with a healthy appetite for higher risk shares – which generally reward them with higher returns – would be well advised to search for the least risky among the risky.

As a case in point, consider the Hastie Group, a provider of a variety of building and construction systems and services.  As you know, commercial and industrial construction has suffered in these troubled times and the Hastie Group (HST) is considered a high-risk share.  

If you are new to the retail investing game you may have yet to suffer the abject shock resulting when trading in the shares of a company in which you have invested is halted on the ASX.  Investors in the Hastie Group found shares halted on 16 February 2011.

While not always the case, this halt was accompanied by a statement from the company, explaining why they requested the halt.  Here is part of what they had to say:

•    In the lead up to the release of its half-year results, Hastie Group has been reviewing its expected full year financial performance.  As part of that process, it is entering discussions with its lender group to discuss its financial performance and any implications for its capital structure.  The Trading Halt is sought to assist Hastie Group to manage its disclosure obligations in relation to the ongoing discussions with its lender group and to maintain an orderly market in the trading of its shares.  Hastie Group hopes to be in a position to make a detailed statement to the market in due course.

This spells trouble with meeting debt obligations and if you have been following the company, you know they renegotiated repayment terms in December 2010.  At this point, no one knows for sure what will happen, but the most likely outcome appears to an equity offering to raise cash, which will lead to shareholder dilution.  

Given the downturn in their business environment, was it at all predictable they would not have sufficient cash to see them through?  These Cash Flow Indicators may have provided a clue:

1.    Cash Flow to Debt Ratio

2.    Operating Cash Flow/Sales Ratio

3.    Cash Flow Coverage Ratio

Cash Flow to Debt Ratio

Cash flow is the difference between revenue generated and received by a company and revenue going out in expenditures.  The Cash Flow to Debt Ratio is a broad ratio measuring the company’s ability to meet debt obligations in a given period, usually a year.  Debt obligations include both the total long-term debt and the part of that debt payable in the time period as well as short-term debt, due in full during the year.  Here is the formula for the ratio:

Cash Flow (CF) to Debt Ratio = Operating Cash Flow (OCF)/Total Debt

To calculate the ratio we will need to check Hastie Group’s Statement of Cash Flows and Balance Sheet (Statement of Financial Position).  As of 30 June 2010, HST’s Cash Flow to Debt Ratio was .089.  The higher the number, the better the company’s position to carry the debt it has.  .089 does not look very impressive.

Operating Cash Flow/Sales Ratio

How well does a company translate its sales into cash?  The Operating Cash Flow (OCF)/Sales Ratio gives an indication.  Here is the formula:

OCF/Sales Ratio = OCF/Net Sales or Revenue from Sale of Goods and Services.

 A trip into HST’s financial statements yields the following – 3.6%.  To look at the ratio from another perspective, HST is turning around 4 cents of every sales dollar into cash.

Cash Flow Coverage Ratio

This ratio measures a company’s ability to meet or “cover” debt due in the current year with its current cash flow, and is calculated as follows:

Cash Flow Coverage = Operating Cash Flow/Short Term Debt

For this ratio the Statement of Cash Flow gives you the numerator and the denominator – Short Term Debt – can be found on the Balance Sheet (Statement of Financial Position) under Current Liabilities.  It includes debt due in the time period as well as the portion of long-term debt due in the current period.  Hastie’s Cash Flow Coverage is .21.

The sad fact here is this ratio tells you the number of times a company’s current or short-term debt obligations can be met by the cash flow generated from operating activities.  Looking at the .21 result is a good indication why HST renegotiated its payment terms.

These ratios would certainly seem to indicate HST was an extremely high-risk investment, at best.  To illustrate further the degree of risk, let us compare HST to another company in the broad industry category – Leighton Holding (LEI)

In truth, the comparison is not apples to apples, since LEI is much larger and operates in more business segments than does the Hastings Group.  However, Leighton Holdings business operations put the company squarely in the danger zone from downturns in commercial and industrial construction activity.  The following chart compares the three Cash Flow Indicator Ratios discussed for the two companies.


CF to Debt  0.089  0.60
OCF/Sales  Ratio  0.036  11.9
CF Coverage Ratio  0.21  1.0


The numbers speak for themselves.  LEI has about 7 times the capacity to manage total debt through Cash Flow than does HST.  LEI returns about 12 cents on every dollar in sales and can cover its current debt through current cash flow from operations.

Next week we will know the outcome of HST’s deliberations with its lender group and we will drill down a little deeper in that situation to see what else we might learn from it.