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Here's Why Schmitt Industries (NASDAQ:SMIT) Might Be Better Off Without Debt

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. As with many other companies Schmitt Industries, Inc. (NASDAQ:SMIT) makes use of debt. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Schmitt Industries

What Is Schmitt Industries's Net Debt?

You can click the graphic below for the historical numbers, but it shows that as of February 2019 Schmitt Industries had US$57.0k of debt, an increase on none, over one year. However, its balance sheet shows it holds US$1.17m in cash, so it actually has US$1.11m net cash.

NasdaqCM:SMIT Historical Debt, July 26th 2019
NasdaqCM:SMIT Historical Debt, July 26th 2019

How Healthy Is Schmitt Industries's Balance Sheet?

According to the last reported balance sheet, Schmitt Industries had liabilities of US$1.82m due within 12 months, and liabilities of US$35.6k due beyond 12 months. Offsetting these obligations, it had cash of US$1.17m as well as receivables valued at US$2.08m due within 12 months. So it actually has US$1.39m more liquid assets than total liabilities.

This excess liquidity suggests that Schmitt Industries is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Schmitt Industries has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Schmitt Industries will need earnings to service that debt. 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 Schmitt Industries's revenue was pretty flat. While that hardly impresses, its not too bad either.

So How Risky Is Schmitt Industries?

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 Schmitt Industries had negative earnings before interest and tax (EBIT), truth be told. And over the same period it saw negative free cash outflow of US$874k and booked a US$716k accounting loss. But at least it has US$1.2m on the balance sheet to spend on growth, near-term. 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 Schmitt Industries I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.