Is the company's cash its own? Dig Deeper.

Cash rich companies are very popular with investors for more than one reason. A firm that has a healthy cash balance can utilize it productively for capacity expansion, acquisitions or rewarding investors. These cash rich companies are also in a stronger position to tide over a business slowdown.

However, making the right decisions on how to use the excess cash is not easy. For example, should one reward investors via paying out dividends or share repurchase?

What is important is that the cash visible on the books of the company may not all be "free cash". That is, some of the cash shown in the company's books may actually not be at its disposal for the purposes indicated above.

Funds are often kept with a bank as a margin or collateral deposit. Then, this cash used as margin or collateral is essentially "locked" and cannot be considered as free cash. And that cash is no longer available for capital expenditure, acquisitions or rewarding investors.

For example, a jewellery exporter Shree Ganesh Jewellery House shows huge cash reserves of Rs.6.4 bn on its balance sheet. This implies a cash per share of Rs 106 (Current Market Price= Rs 112) in 2011. This may make the company seem like a very attractive investment. However, a closer look at the composition of this cash amount reveals that most of it (Rs 6.1 bn) is deposited as margin money with banks. The margin money is the amount that Shree Ganesh parks as deposits with banks against gold that it procures from or through them, and so this amount is not available for other purposes.

While analyzing the company's financials, investors may mistakenly consider the total cash shown in the reports as free cash. But as we demonstrated above, this is not true if any of the cash is tied up as margin or collateral.

Investor beware - what is free and real cash ... and not?

How do we know what is the free cash of this company?

Interestingly the company's annual report clearly states that this Rs. 6.1bn "margin" money cannot be used for other purposes such as repayment of debt, expansion or mergers and acquisitions.

So , as an investor, just looking at the Profit and Loss (P&L) and Balance Sheet (BS) does not represent the true picture of a company's financial situation. We need to delve deeper into the line items, and carefully read the finer details of the annual report (notes to accounts, auditor's notes etc.), and analyse this content along with the management guidance before arriving at our investment decision.

This careful and studied approach will help us in unearthing the real free cash to determine if the company is truly cash rich so that it can invest to grow. And this will tell us if it is a potential stock to consider from a long term investment perspective.