Companies with High Debtors

   

Investing in companies with high debtors may be tempting, because debtors are the assets which the company expects to realise over the period for the sales made on credit to the customers. However, doing so is loaded with risks. We short-listed companies that have substantial debtors, which forms more than 50 per cent of the total assets of the company and have negative cash flow from operating activities.

Such companies operate in a very delicate position because there is the fear of defaults by major debtors or even delays, which could send their books to doldrums. On analysing the companies we figured that these debtors are almost equal or are more than the net worth of the companies. This means any defaulting client could throw the company into negative net worth.

Although these companies may continue to operate without any issues; they are risky to invest. The reason for such risks stems from the fact that a company's physical assets, inventories, though realisable at any point of time, many not be 100 per cent realisable in short notice in extreme cases.

The lesson: having substantial debtors compared to total assets defies the 'bird in hand' theory. It is better to have assets in hand than that is assumed for future. Moreover, having high debtors also puts strain on the working capital because the cash which could have been utilised after the sales is still not available. And, when the cash from operations is negative; it puts the company in a state where it then depends on loans for even day to day operations.