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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Corero Network Security plc (LON:CNS) makes use of debt. 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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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. 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 Corero Network Security Carry?
The image below, which you can click on for greater detail, shows that at December 2021 Corero Network Security had debt of US$2.78m, up from US$2.48m in one year. However, its balance sheet shows it holds US$11.2m in cash, so it actually has US$8.42m net cash.
How Strong Is Corero Network Security's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Corero Network Security had liabilities of US$10.3m due within 12 months and liabilities of US$3.72m due beyond that. Offsetting this, it had US$11.2m in cash and US$3.21m in receivables that were due within 12 months. So it actually has US$423.0k more liquid assets than total liabilities.
Having regard to Corero Network Security's size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the US$75.8m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that Corero Network Security has more cash than debt is arguably a good indication that it can manage its debt safely.
Notably, Corero Network Security made a loss at the EBIT level, last year, but improved that to positive EBIT of US$1.1m in the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Corero Network Security'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, a company can only pay off debt with cold hard cash, not accounting profits. Corero Network Security 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. During the last year, Corero Network Security produced sturdy free cash flow equating to 53% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Corero Network Security has US$8.42m in net cash and a decent-looking balance sheet. So we are not troubled with Corero Network Security's debt use. 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. Case in point: We've spotted 3 warning signs for Corero Network Security you should be aware of, and 1 of them is potentially serious.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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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.