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. We can see that SRG Global Limited (ASX:SRG) does use debt in its business. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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, 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for SRG Global

How Much Debt Does SRG Global Carry?

The image below, which you can click on for greater detail, shows that SRG Global had debt of AU$31.7m at the end of December 2021, a reduction from AU$35.0m over a year. However, it does have AU$60.0m in cash offsetting this, leading to net cash of AU$28.3m.

How Healthy Is SRG Global's Balance Sheet?

According to the last reported balance sheet, SRG Global had liabilities of AU$165.5m due within 12 months, and liabilities of AU$34.0m due beyond 12 months. Offsetting these obligations, it had cash of AU$60.0m as well as receivables valued at AU$114.9m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$24.5m.

Of course, SRG Global has a market capitalization of AU$271.9m, so these liabilities are probably manageable. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, SRG Global also has more cash than debt, so we're pretty confident it can manage its debt safely.

It was also good to see that despite losing money on the EBIT line last year, SRG Global turned things around in the last 12 months, delivering and EBIT of AU$28m. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if SRG Global can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While SRG Global 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. Happily for any shareholders, SRG Global actually produced more free cash flow than EBIT over the last year. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that SRG Global has AU$28.3m in net cash. The cherry on top was that in converted 132% of that EBIT to free cash flow, bringing in AU$37m. So we don't think SRG Global's use of debt is risky. 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. Case in point: We've spotted 1 warning sign for SRG Global 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.

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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.