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Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. Importantly, Imdex Limited (ASX:IMD) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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. 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 Imdex Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Imdex had debt of AU$12.8m, up from AU$6.20m in one year. However, its balance sheet shows it holds AU$59.8m in cash, so it actually has AU$47.0m net cash.
A Look At Imdex's Liabilities
We can see from the most recent balance sheet that Imdex had liabilities of AU$48.6m falling due within a year, and liabilities of AU$56.5m due beyond that. Offsetting these obligations, it had cash of AU$59.8m as well as receivables valued at AU$42.2m due within 12 months. So its liabilities total AU$3.13m more than the combination of its cash and short-term receivables.
Having regard to Imdex's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the AU$779.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Imdex also has more cash than debt, so we're pretty confident it can manage its debt safely.
The modesty of its debt load may become crucial for Imdex if management cannot prevent a repeat of the 27% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Imdex 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, a company can only pay off debt with cold hard cash, not accounting profits. While Imdex has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. Over the most recent three years, Imdex recorded free cash flow worth 74% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.
We could understand if investors are concerned about Imdex's liabilities, but we can be reassured by the fact it has has net cash of AU$47.0m. And it impressed us with free cash flow of AU$38m, being 74% of its EBIT. So we don't have any problem with Imdex'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 3 warning signs for Imdex that you should be aware of.
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.
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.
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