Question

Should I invest in company with a positive Equity balance but small profits or a company with a negative Equity balance but huge profits? explain the steps you would take before making a final decision. Explain the steps you would take before making a final decision.

Answer 1

You should invest in a company with a positive equity balance but small profits rather than investing in a company with negative equity balance but huge profits. This is because negative equity is more often than not a warning sign with regards to financial distress of a company. It could indicate that a company has large amount of accumulated losses or has a large dividend payments. It could also mean that the company has borrowed money to cover its accumulated losses.

Before making the financial decision I would like to take some steps. First and most importantly I will have to determine the cause for the negative equity. I should determine if the negative equity is being caused by large amount of accumulated losses or if it is being caused by large dividend payments by the company. Secondly I will look at the cash flow situation of the company. If the company has a negative equity but is still generating good amount of free cash flows then the negative equity situation should not be much of a problem.