Berkshire Hathaway’s Charlie Munger-backed external fund manager Li Lu is quick to say this when he says “The biggest risk in investing is not price volatility, but if you will suffer a loss. permanent capital “. So it seems like smart money knows that debt – which is usually involved in bankruptcies – is a very important factor, when you assess the level of risk of a business. We note that Limited Allied Farmers (NZSE: ALF) has debt on its balance sheet. But does this debt concern shareholders?
When Is Debt a Problem?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, then it exists at their mercy. In the worst case scenario, a business can go bankrupt if it cannot pay its creditors. However, a more common (but still costly) event is when a company has to issue stock at bargain prices, constantly diluting shareholders, just to strengthen its balance sheet. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
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How much debt do Allied farmers carry?
The image below, which you can click for more details, shows Allied Farmers owed NZ $ 3.04 million in debt at the end of June 2021, a reduction from 3.79 million of New Zealand dollars over one year. But he also has NZ $ 4.54 million in cash to make up for that, which means he has a net cash position of NZ $ 1.50 million.
A look at the responsibilities of allied farmers
Zooming in on the latest balance sheet data, we can see that Allied Farmers had a liability of NZ $ 14.9 million owed within 12 months and a liability of NZ $ 2.83 million owed to- of the. On the other hand, he had NZ $ 4.54 million in cash and NZ $ 15.5 million in receivables due within a year. So he actually has NZ $ 2.28 million Following liquid assets as total liabilities.
This short-term liquidity is a sign that Allied Farmers could probably pay off debt easily, as its balance sheet is far from tight. Put simply, the fact that Allied Farmers has more cash than debt is arguably a good indication that it can safely manage its debt.
Even more impressively, Allied Farmers increased its EBIT by 163% year over year. If sustained, this growth will make debt even more manageable in the years to come. The balance sheet is clearly the area to focus on when analyzing debt. But you can’t look at debt in isolation; since Allied Farmers will need income to pay off this debt. So if you want to know more about its profits, it might be worth checking out this long term profit trend chart.
Finally, a business can only repay its debts with hard cash, not with book profits. While Allied Farmers has net cash on their balance sheet, it’s still worth looking at their ability to convert earnings before interest and taxes (EBIT) into free cash flow, to help us understand how fast they are building. (or erode) this cash balance. Over the past three years, Allied Farmers has actually generated more free cash flow than EBIT. This kind of solid money generation warms our hearts like a puppy in a bumblebee costume.
In summary
While we sympathize with investors who find the debt of concern, you should keep in mind that Allied Farmers has NZ $ 1.50 million in net cash, as well as more liquid assets than of liabilities. The icing on the cake was that he converted 124% of that EBIT into free cash flow, bringing in NZ $ 3.7 million. So we don’t think Allied Farmers’ use of debt is risky. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist off the balance sheet. For example, Allied Farmers has 4 warning signs (and 2 that are of concern) we think you should be aware of.
Of course, if you are the type of investor who prefers to buy stocks without going into debt, feel free to check out our exclusive list of cash net growth stocks today.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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