Companies fail largely because their businesses are poorly financed. A strong balance sheet tells you many things. Most importantly, it tells you that the company is very unlikely to fail. But balance sheet strength is not just about the liabilities. It’s also important to look at the assets. What a company does with its cash is very instructive. Does it have too much? Is it gambling with it by investing it in exotic financial instruments? Cash generation is paramount but, once generated, a company must invest it wisely, keep it safe or pass it to shareholders. A balance sheet is like a backbone; it tells you about the character of a company.
Hugh Young is managing director at Aberdeen Asset Management Asia.