Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Akasol AG (ETR:ASL) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Akasol's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2019 Akasol had debt of €4.50m, up from €6.4 in one year. But it also has €38.9m in cash to offset that, meaning it has €34.4m net cash.
A Look At Akasol's Liabilities
The latest balance sheet data shows that Akasol had liabilities of €15.8m due within a year, and liabilities of €3.73m falling due after that. Offsetting these obligations, it had cash of €38.9m as well as receivables valued at €12.5m due within 12 months. So it can boast €31.9m more liquid assets than total liabilities.
This short term liquidity is a sign that Akasol could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Akasol has more cash than debt is arguably a good indication that it can manage its debt safely.
It was also good to see that despite losing money on the EBIT line last year, Akasol turned things around in the last 12 months, delivering and EBIT of €62k. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Akasol can strengthen its balance sheet over time. 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. Akasol 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. Over the last year, Akasol saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
While we empathize with investors who find debt concerning, you should keep in mind that Akasol has net cash of €34.4m, as well as more liquid assets than liabilities. So we don't have any problem with Akasol's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 1 warning sign for Akasol that you should be aware of.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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