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Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that One Stop Systems, Inc. (NASDAQ:OSS) does use debt in its business. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.
What Is One Stop Systems's Net Debt?
You can click the graphic below for the historical numbers, but it shows that One Stop Systems had US$2.22m of debt in March 2022, down from US$5.17m, one year before. However, its balance sheet shows it holds US$15.8m in cash, so it actually has US$13.5m net cash.
How Strong Is One Stop Systems' Balance Sheet?
According to the last reported balance sheet, One Stop Systems had liabilities of US$10.9m due within 12 months, and liabilities of US$794.4k due beyond 12 months. Offsetting this, it had US$15.8m in cash and US$9.08m in receivables that were due within 12 months. So it can boast US$13.2m more liquid assets than total liabilities.
This excess liquidity suggests that One Stop Systems is taking a careful approach to debt. Because it has plenty of assets, it is unlikely to have trouble with its lenders. Succinctly put, One Stop Systems boasts net cash, so it's fair to say it does not have a heavy debt load!
In addition to that, we're happy to report that One Stop Systems has boosted its EBIT by 56%, thus reducing the spectre of future debt repayments. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine One Stop Systems's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. One Stop Systems may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, One Stop Systems basically broke even on a free cash flow basis. While many companies do operate at break-even, we prefer see substantial free cash flow, especially if a it already has dead.
While it is always sensible to investigate a company's debt, in this case One Stop Systems has US$13.5m in net cash and a decent-looking balance sheet. And it impressed us with its EBIT growth of 56% over the last year. So we don't think One Stop Systems's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For example One Stop Systems has 4 warning signs (and 1 which is a bit unpleasant) we think you should know about.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.