David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Cannasouth Limited (NZSE:CBD) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
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 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Cannasouth Carry?
You can click the graphic below for the historical numbers, but it shows that as of December 2021 Cannasouth had NZ$2.87m of debt, an increase on none, over one year. However, it does have NZ$5.52m in cash offsetting this, leading to net cash of NZ$2.64m.
A Look At Cannasouth's Liabilities
The latest balance sheet data shows that Cannasouth had liabilities of NZ$1.72m due within a year, and liabilities of NZ$4.72m falling due after that. Offsetting this, it had NZ$5.52m in cash and NZ$424.5k in receivables that were due within 12 months. So it has liabilities totalling NZ$499.0k more than its cash and near-term receivables, combined.
This state of affairs indicates that Cannasouth's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the NZ$45.3m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Cannasouth also has more cash than debt, so we're pretty confident it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Cannasouth's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
In the last year Cannasouth wasn't profitable at an EBIT level, but managed to grow its revenue by 893%, to NZ$1.3m. When it comes to revenue growth, that's like nailing the game winning 3-pointer!
So How Risky Is Cannasouth?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And in the last year Cannasouth had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through NZ$3.4m of cash and made a loss of NZ$2.9m. But the saving grace is the NZ$2.64m on the balance sheet. That means it could keep spending at its current rate for more than two years. The good news for shareholders is that Cannasouth has dazzling revenue growth, so there's a very good chance it can boost its free cash flow in the years to come. While unprofitable companies can be risky, they can also grow hard and fast in those pre-profit years. 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. Case in point: We've spotted 4 warning signs for Cannasouth you should be aware of, and 1 of them is significant.
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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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.