Sunday, August 8, 2010

What the Heck is a 'Super Stress Test'?

I've been getting some question about what is a 'super stress test'. Well, you won't find this in books it is just a ratio I come out with. That is why the name sounds a bit weird.

In a normal liquid test, we use (Current Assets-Inventories):Current Liabilities to test the liquidity of a company. The logic behind this as what Buffett has mention before, inventories can't be taken as a liquid asset as it is difficult to turn inventories into cash in the case of emergency and definitely not within a day or 2. Even if a company manages to turn them into cash, it might be well below its current value written in the balance sheet because if this were to happen, the company becomes a desperate seller.

So how about 'super stress test'? This test exclude another element, Trade Receivables, where liquid assets become Current Assets-Inventories-Receivables or just Cash & Equivalent. Okay, this is an extreme case and it is not really relevant to most product based companies. However it is more applicable to project based companies or a company who has less diversify customer base (for me I take less than 10). It is to see, how well a company could cope if its customers were to default payment. One good example is LCL and DIS Tech. LCL especially looks good in the liquid test but they have extremely high receivables. And worst of all, most of them (90% if I'm not wrong) come from a single customer which is in Dubai. So when this 'you know who' defaults payment, LCL run into the mess that they have today.

However, this is an extreme case test where it is assume all receivables are defaulted. It is pretty unlikely to happen to companies with huge customers base.

1 comment:

Anonymous said...

Genial dispatch and this mail helped me alot in my college assignement. Thanks you as your information.