Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Avicanna Inc. (TSE:AVCN) does use debt in its business. But is this debt a concern to shareholders?
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. When we think about a company's use of debt, we first look at cash and debt together.
What Is Avicanna's Net Debt?
You can click the graphic below for the historical numbers, but it shows that as of June 2019 Avicanna had CA$2.04m of debt, an increase on CA$15.0k, over one year. However, its balance sheet shows it holds CA$13.0m in cash, so it actually has CA$10.9m net cash.
How Strong Is Avicanna's Balance Sheet?
The latest balance sheet data shows that Avicanna had liabilities of CA$4.13m due within a year, and liabilities of CA$1.20m falling due after that. Offsetting this, it had CA$13.0m in cash and CA$397.1k in receivables that were due within 12 months. So it can boast CA$8.05m more liquid assets than total liabilities.
This surplus suggests that Avicanna has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Avicanna has more cash than debt is arguably a good indication that it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Avicanna will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
It seems likely shareholders hope that Avicanna can significantly advance the business plan before too long, because it doesn't have any significant revenue at the moment.
So How Risky Is Avicanna?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Avicanna had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of CA$15m and booked a CA$14m accounting loss. With only CA$10.9m on the balance sheet, it would appear that its going to need to raise capital again soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. For riskier companies like Avicanna I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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