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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. As with many other companies Kromek Group plc (LON:KMK) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Kromek Group's Debt?
The image below, which you can click on for greater detail, shows that at April 2019 Kromek Group had debt of UK£5.45m, up from UK£3.00m in one year. However, its balance sheet shows it holds UK£20.6m in cash, so it actually has UK£15.2m net cash.
How Strong Is Kromek Group's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Kromek Group had liabilities of UK£8.29m due within 12 months and liabilities of UK£6.25m due beyond that. Offsetting these obligations, it had cash of UK£20.6m as well as receivables valued at UK£21.0m due within 12 months. So it actually has UK£27.1m more liquid assets than total liabilities.
This surplus liquidity suggests that Kromek Group's balance sheet could take a hit just as well as Homer Simpson's head can take a punch. With this in mind one could posit that its balance sheet is as strong as beautiful a rare rhino. Simply put, the fact that Kromek Group 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 ultimately the future profitability of the business will decide if Kromek Group 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.
In the last year Kromek Group managed to grow its revenue by 23%, to UK£15m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Kromek Group?
By their very nature companies that are losing money are more risky than those with a long history of profitability. And we do note that Kromek Group had negative earnings before interest and tax (EBIT), over the last year. And over the same period it saw negative free cash outflow of UK£11m and booked a UK£283k accounting loss. However, it has net cash of UK£21m, so it has a bit of time before it will need more capital. With very solid revenue growth in the last year, Kromek Group may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. For riskier companies like Kromek Group I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.
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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If you spot an error that warrants correction, please contact the editor at email@example.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.