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. 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, Alpha Financial Markets Consulting plc (LON:AFM) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt A Problem?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we think about a company's use of debt, we first look at cash and debt together.
What Is Alpha Financial Markets Consulting's Debt?
As you can see below, at the end of March 2020, Alpha Financial Markets Consulting had UK£5.00m of debt, up from none a year ago. Click the image for more detail. However, it does have UK£26.0m in cash offsetting this, leading to net cash of UK£21.0m.
How Healthy Is Alpha Financial Markets Consulting's Balance Sheet?
We can see from the most recent balance sheet that Alpha Financial Markets Consulting had liabilities of UK£35.9m falling due within a year, and liabilities of UK£13.4m due beyond that. Offsetting this, it had UK£26.0m in cash and UK£20.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by UK£3.01m.
This state of affairs indicates that Alpha Financial Markets Consulting's balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the UK£189.3m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Alpha Financial Markets Consulting boasts net cash, so it's fair to say it does not have a heavy debt load!
But the bad news is that Alpha Financial Markets Consulting has seen its EBIT plunge 17% 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 Alpha Financial Markets Consulting 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 business needs free cash flow to pay off debt; accounting profits just don't cut it. Alpha Financial Markets Consulting may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last three years, Alpha Financial Markets Consulting actually produced more free cash flow than EBIT. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.
While it is always sensible to look at a company's total liabilities, it is very reassuring that Alpha Financial Markets Consulting has UK£21.0m in net cash. And it impressed us with free cash flow of UK£16m, being 137% of its EBIT. So we are not troubled with Alpha Financial Markets Consulting'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. Consider risks, for instance. Every company has them, and we've spotted 2 warning signs for Alpha Financial Markets Consulting you should know about.
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
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.
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