Estimating excess cash on the balance sheet

[bean]

After buying a stable, no-growth business for its market cap and paying off its short and long-term debt, how much excess cash can be extracted from its balance sheet?

 

Here are three estimates:

A) All cash and securities.

    This is the from the simplified definition of EV.

B) All cash and securities, as long as the current ratio is at least 2.

    This is more realistic, since the business needs cash to rebuild inventory, pay employees etc.

C) All cash and securities after leaving a buffer to cover the costs of one cash conversion cycle (CCC), e.g. CCC * (COGS+SG&A)/365.

 

EV/EBIT and ROIC values can vary greatly depending on whether A, B or C is used. What are some other approaches to estimating excess cash?

[augustabound]

I think this is from Mohnish Pabrai;

Excess Capital = Book Value – Fixed Assets – Goodwill – Working Capital Needed for Operations (2% of Sales)

[Packer16]

Excess cash is dependent upon industry so you need to look at what the comps have and any in excess of the high end of the range is a reasonable estimate.  However you have to understand the cash cycle of the industry also to identify excess cash.

 

Packer

[west]

Bruce Greenwald's Competition Demystified book has excess cash defined as All Cash - 1% of Sales.  This is what I use when doing valuations, but it's a grossly simplified estimate.  What Packer recommends is probably the best approach.

[Patmo]

Excess cash is dependent upon industry so you need to look at what the comps have and any in excess of the high end of the range is a reasonable estimate.  However you have to understand the cash cycle of the industry also to identify excess cash.

 

Packer

 

Obviously, size of the comp (and other things) can affect the meaning of a comp's cash balance. What should be used as a basis of comparison to scale? % of Total assets?

[jmaes]

I use "cash - max(0, current liabilities - non cash current assets)".

 

So you first pay of your current liabilities with your current assets that are not cash. Then, if there are any current liabilities left, you use your cash to pay off. Then, what remains I consider as excess cash.

Not sure whether that's a good approach though.

[bean]

Thanks for the pointers everyone. These all look like useful rules-of-thumb.

 

Excess cash is dependent upon industry so you need to look at what the comps have and any in excess of the high end of the range is a reasonable estimate.  However you have to understand the cash cycle of the industry also to identify excess cash.

 

Packer

 

For a general screen (before digging into the details of each company and industry), do you think using the CCC is a good estimate for your more detailed approach?

 

[SpecOps]

It really depends. There are lots of companies that operate at current ratios well below 1, so current assets dont always have to cover current liabilities depending on how they are managing it.