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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 seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Reko International Group Inc. (CVE:REKO) does carry debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. 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 Reko International Group's Net Debt?
As you can see below, Reko International Group had CA$8.93m of debt, at January 2022, which is about the same as the year before. You can click the chart for greater detail. But it also has CA$10.8m in cash to offset that, meaning it has CA$1.91m net cash.
A Look At Reko International Group's Liabilities
We can see from the most recent balance sheet that Reko International Group had liabilities of CA$11.0m falling due within a year, and liabilities of CA$4.53m due beyond that. Offsetting this, it had CA$10.8m in cash and CA$21.7m in receivables that were due within 12 months. So it actually has CA$17.0m more liquid assets than total liabilities.
This excess liquidity is a great indication that Reko International Group's balance sheet is almost as strong as Fort Knox. On this view, lenders should feel as safe as the beloved of a black-belt karate master. Succinctly put, Reko International Group boasts net cash, so it's fair to say it does not have a heavy debt load!
Although Reko International Group made a loss at the EBIT level, last year, it was also good to see that it generated CA$2.6m in EBIT over the last twelve months. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Reko International Group's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.
Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Reko International Group 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. Over the last year, Reko International Group saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.
While it is always sensible to investigate a company's debt, in this case Reko International Group has CA$1.91m in net cash and a decent-looking balance sheet. So we are not troubled with Reko International Group's debt use. 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. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Reko International Group (of which 1 is a bit concerning!) you should know about.
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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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.