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Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that LBT Innovations Limited (ASX:LBT) does use debt in its business. But should shareholders be worried about its use of debt?
When Is Debt A Problem?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is LBT Innovations's Debt?
The image below, which you can click on for greater detail, shows that LBT Innovations had debt of AU$2.94m at the end of June 2021, a reduction from AU$3.86m over a year. But it also has AU$9.62m in cash to offset that, meaning it has AU$6.68m net cash.
A Look At LBT Innovations' Liabilities
According to the last reported balance sheet, LBT Innovations had liabilities of AU$2.58m due within 12 months, and liabilities of AU$8.23m due beyond 12 months. Offsetting this, it had AU$9.62m in cash and AU$1.95m in receivables that were due within 12 months. So it actually has AU$758.0k more liquid assets than total liabilities.
Having regard to LBT Innovations' size, it seems that its liquid assets are well balanced with its total liabilities. So it's very unlikely that the AU$40.5m company is short on cash, but still worth keeping an eye on the balance sheet. Simply put, the fact that LBT Innovations 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 LBT Innovations will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Given its lack of meaningful operating revenue, LBT Innovations shareholders no doubt hope it can fund itself until it can sell some of its new medical technology.
So How Risky Is LBT Innovations?
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 LBT Innovations had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$3.3m and booked a AU$7.3m accounting loss. However, it has net cash of AU$6.68m, so it has a bit of time before it will need more capital. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. For instance, we've identified 4 warning signs for LBT Innovations (2 don't sit too well with us) 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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