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 The Providence Service Corporation (NASDAQ:PRSC) makes use of debt. But is this debt a concern to shareholders?
When Is Debt A Problem?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Providence Service's Debt?
You can click the graphic below for the historical numbers, but it shows that as of March 2020 Providence Service had US$162.0m of debt, an increase on none, over one year. However, its balance sheet shows it holds US$254.4m in cash, so it actually has US$92.4m net cash.
How Healthy Is Providence Service's Balance Sheet?
According to the last reported balance sheet, Providence Service had liabilities of US$329.1m due within 12 months, and liabilities of US$62.5m due beyond 12 months. On the other hand, it had cash of US$254.4m and US$175.7m worth of receivables due within a year. So it can boast US$38.5m more liquid assets than total liabilities.
This surplus suggests that Providence Service has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Providence Service boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Providence Service has seen its EBIT plunge 20% in the last twelve months. If that rate of decline in earnings continues, the company could find itself in a tight spot. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Providence Service 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 Providence Service 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 three years, Providence Service produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Providence Service has US$92.4m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$50m, being 69% of its EBIT. So we are not troubled with Providence Service's debt use. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example - Providence Service has 4 warning signs we think you should be aware of.
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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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. Thank you for reading.