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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a 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 One Stop Systems, Inc. (NASDAQ:OSS) makes use of debt. But is this debt a concern to shareholders?
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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. When we examine debt levels, we first consider both cash and debt levels, together.
What Is One Stop Systems's Net Debt?
The image below, which you can click on for greater detail, shows that at September 2020 One Stop Systems had debt of US$5.48m, up from US$2.98m in one year. But it also has US$5.52m in cash to offset that, meaning it has US$39.7k net cash.
A Look At One Stop Systems' Liabilities
According to the last reported balance sheet, One Stop Systems had liabilities of US$10.5m due within 12 months, and liabilities of US$2.40m due beyond 12 months. Offsetting this, it had US$5.52m in cash and US$9.74m in receivables that were due within 12 months. So it actually has US$2.35m more liquid assets than total liabilities.
This short term liquidity is a sign that One Stop Systems could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that One Stop Systems has more cash than debt is arguably a good indication that it can manage its debt safely.
Although One Stop Systems made a loss at the EBIT level, last year, it was also good to see that it generated US$881k in EBIT over the last twelve months. There's no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if One Stop Systems 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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While One Stop Systems 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. During the last year, One Stop Systems burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.
While we empathize with investors who find debt concerning, you should keep in mind that One Stop Systems has net cash of US$39.7k, as well as more liquid assets than liabilities. So we don't have any problem with One Stop Systems's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for One Stop Systems you should be aware of.
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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