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Does Energy Focus (NASDAQ:EFOI) Have A Healthy Balance Sheet?

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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. 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 note that Energy Focus, Inc. (NASDAQ:EFOI) does have debt on its balance sheet. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Energy Focus

What Is Energy Focus's Debt?

You can click the graphic below for the historical numbers, but it shows that Energy Focus had US$1.64m of debt in March 2020, down from US$3.42m, one year before. But on the other hand it also has US$2.91m in cash, leading to a US$1.27m net cash position.

NasdaqCM:EFOI Historical Debt June 24th 2020
NasdaqCM:EFOI Historical Debt June 24th 2020

How Strong Is Energy Focus's Balance Sheet?

We can see from the most recent balance sheet that Energy Focus had liabilities of US$5.67m falling due within a year, and liabilities of US$865.0k due beyond that. On the other hand, it had cash of US$2.91m and US$1.90m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$1.72m.

Of course, Energy Focus has a market capitalization of US$21.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. Despite its noteworthy liabilities, Energy Focus boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Energy Focus 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.

Over 12 months, Energy Focus made a loss at the EBIT level, and saw its revenue drop to US$13m, which is a fall of 20%. That's not what we would hope to see.

So How Risky Is Energy Focus?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And the fact is that over the last twelve months Energy Focus lost money at the earnings before interest and tax (EBIT) line. And over the same period it saw negative free cash outflow of US$2.7m and booked a US$5.0m accounting loss. But at least it has US$1.27m on the balance sheet to spend on growth, near-term. Summing up, we're a little skeptical of this one, as it seems fairly risky in the absence of free cashflow. 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. Be aware that Energy Focus is showing 5 warning signs in our investment analysis , and 1 of those is a bit unpleasant...

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.

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. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.