Two companies… the same balance… two different fates
A contracting company has a cash balance of KD 5 million. Its manager boasts: we are strong. Another company has the same balance, but its projects have stalled and salaries are in arrears. The same figure in the balance sheet, but an entirely different reality.
Two million may be earmarked for letters of guarantee, one million may be a deposit tied to credit facilities, and one million may be for salaries and suppliers in the near term. The headline figure is 5 million, but the free liquidity is far lower. The right question is not “how much do we have?” but rather: “how much can we use now without putting our operations at risk?”
Plenty of cash is not necessarily success
There is no fixed rule requiring you to hold cash covering three months. The right figure depends on the nature of the business, the collection cycle, commitments and seasonality. Three months is merely a starting point.
A balance of 5 million and monthly expenses of 500 thousand do not mean that you have 3.5 million “surplus”. Part of it may be earmarked for expansion, for commitments or as a risk reserve. The problem begins when surplus cash sits with no clear purpose, earning a return below the cost of funding or inflation.
In a high interest-rate environment, the opportunity cost has risen. Keeping large sums in a current account means giving up real returns. Under IAS 7, the source of the cash must be analysed: did it come from operating activities, from the sale of an asset, or from borrowing?
Little cash is not poverty or weak management of the company; it may instead be smart, sound use of cash
An entity with only KD 200,000 that turns over its stock quickly and collects what it is owed efficiently may be more efficient than an entity sitting on idle millions. And a company with approved but undrawn bank facilities may be in a better liquidity position than another with millions lying dormant and no plan.
The risk that IFRS 7 exposes
Look at liquidity risk, not just at the bank balance. Do you have restricted or pledged balances? Many balance sheets show “cash of 3 million” while the notes disclose that a significant part of it is restricted. Ask: how much cash is actually available right now? And one of the risks many overlook is concentration of cash in a single bank. Even if the balance is large, any restriction on it turns the headline figure into illusory liquidity.
Where did the profit go?
Profit is not cash. A company may make a profit of KD 1 million, but if receivables rise, the profits appear while the cash has not yet come in. The question is not only “how much did we make?” but “where did the profit go?” A company can be profitable in accounting terms and under cash pressure at one and the same time.
The cash paradox
Sometimes a company with 10 million is financially weaker than a company with just one million, because the first is weighed down by short-term liabilities while the second has strong operating cash flows and undrawn facilities. Size does not create liquidity… the ability to meet obligations is what creates it.
What does IFRS 18 reveal?
IFRS 18 requires an entity to separate the results of its operating activities from its other sources of income. Net profit may look strong, but once they are separated you discover that the core business is weaker than the bottom-line figure suggests. Real strength lies in the core business’s ability to generate sustainable profits and cash flows, not in returns on temporary deposits.
The 30-day test
Ask management: if revenue stopped for 30 days, for how many days could the entity carry on without borrowing or selling an asset? This is where true liquidity shows. A company may be rich in assets, profitable and holding 5 million, yet be unable to pay its salaries two weeks from now. This is not a profit problem… it is a liquidity problem.
Four practical indicators
First: liquidity adequacy ratio = available cash ÷ monthly cash expenses (a management indicator, not a fixed rule). Second: restricted cash report – identify pledged balances, with the reason for and duration of each restriction. Third: free cash ratio = cash actually available ÷ total cash. Fourth: return on cash = interest income ÷ average cash balance. Weigh the return against liquidity, risk and the cost of the alternatives before making any decision.
5 million in the bank… but how much of it is real?
| Item | Amount |
|---|---|
| Cash and cash equivalents | KD 5,000,000 |
| Restricted / pledged cash | KD (2,000,000) |
| Near-term operating commitments | KD (1,000,000) |
| Cash remaining after commitments | KD 2,000,000 |
Questions for the board of directors
- How much cash do we actually have?
- How much of it is restricted?
- How much do we need to cover 30, 60 and 90 days?
- How much comes from operating activities, and how much from loans or the sale of assets?
- What does it cost to keep cash in a current account?
- What return could the surplus earn without putting liquidity at risk?
- And do we have a written policy on operating, reserve and surplus cash levels?
The management decision
Do not leave surplus cash without a purpose. Divide it into: operating, restricted, reserve, and surplus available for investment. Compare the return on cash with the cost of funding and the opportunity cost. And disclose material restrictions so that users of the financial statements understand how much liquidity is actually available.
Conclusion
The balance sheet may tell you that you have 5 million. But it does not tell you: is this cash free or restricted? Necessary or surplus? Is it generating a return or losing value? And can you use it tomorrow?
Do not just ask “how much do we have?”; ask instead: “how much of it is free, how much is productive, how much of it is necessary, and how much of it is lying dormant?” Liquidity is not what shows in the bank balance… liquidity is your ability to meet your obligations tomorrow morning, without selling an asset at a loss or borrowing under pressure.
Your balance sheet doesn’t lie… but it doesn’t tell the whole truth. Start tomorrow with a single question: how much of the bank balance is available for use over the next 30 days without touching operations?
