Although they surfaced as a gusher rather than a trickle, the problems that brought the W.T. Grant Company into bankruptcy and, ultimately, liquidation, did not develop overnight. Whereas traditional ratio analysis of Grant’s financial statements would not have revealed the existence of many of the company’s problems until 1970 or 1971, careful analysis of the company’s cash flows would have revealed impending doom as much as a decade before the collapse.
Grant’s profitability, turnover and liquidity ratios had trended downward over the 10 years preceding bankruptcy. But the most striking characteristic of the company during that decade was that it generated no cash internally. Although working capital provided by operations remained fairly stable through 1973, this figure (which constitutes net income plus depreciation and is frequently referred to in the financial press as “cash flow”) can be a very poor indicator of a company’s ability to generate cash. Through 1973, the W.T. Grant Company’s operations were a net user, rather than provider, of cash.
Grant’s continuing inability to generate cash from operations should have provided investors with an early signal of problems. Yet, as recently as 1973, Grant stock was selling at nearly 20 times earnings. Investors placed a much higher value on Grant’s prospects than an analysis of the company’s cash flow from operations would have warranted.