We penalise companies where the cash return over the country policy rate is either too high or too low. Additional red flags are awarded when there are unusually large changes in the return on cash. There are a number of reasons to be concerned about returns on cash:
- Absent cash: Low returns on cash suggests that the cash is not in the bank balance during most of the financial period and is only returned to flatter the numbers. This suggests that a company is window dressing its financials in order to present an overly favourable view of its financial position.
- Risky investments: Unusually high returns on cash suggest that a company is investing in risky assets, such as wealth management products, in order to enhance returns.
Cash returns are generally less than a percentage point over the government rate, as shown in Figure 89. Clearly, there are some differences by country which is likely due to the policy rate we have chosen and what it is used for. Countries which have the highest interest rates are also likely to experience the largest changes, as shown in Figure 90.
Under our accounting screen a red flag is triggered when returns on cash less the policy rate is below the 20th percentile or above the 80th relative to industry peers (i.e. it is either very high or very low). Red flags are also triggered when returns are unusually large over 1 and 3 years. Again, this is when the increase is below the 20th percentile relative to industry peers between 2010 and 2015, or the drop exceeds the 80th percentile.