Does Ariadne Australia (ASX:ARA) Have A Healthy Balance Sheet?

Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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. As with many other companies Ariadne Australia Limited (ASX:ARA) makes use of debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

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, 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.

Check out our latest analysis for Ariadne Australia

How Much Debt Does Ariadne Australia Carry?

You can click the graphic below for the historical numbers, but it shows that as of December 2020 Ariadne Australia had AU$18.2m of debt, an increase on AU$4.85m, over one year. But on the other hand it also has AU$31.2m in cash, leading to a AU$12.9m net cash position.

How Healthy Is Ariadne Australia's Balance Sheet?

According to the last reported balance sheet, Ariadne Australia had liabilities of AU$8.14m due within 12 months, and liabilities of AU$27.4m due beyond 12 months. Offsetting these obligations, it had cash of AU$31.2m as well as receivables valued at AU$1.79m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$2.54m.

Of course, Ariadne Australia has a market capitalization of AU$105.0m, so these liabilities are probably manageable. But there are sufficient liabilities that we would certainly recommend shareholders continue to monitor the balance sheet, going forward. While it does have liabilities worth noting, Ariadne Australia also has more cash than debt, so we're pretty confident it can manage its debt safely.

We also note that Ariadne Australia improved its EBIT from a last year's loss to a positive AU$1.1m. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Ariadne Australia will need earnings to service that debt. 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, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Ariadne Australia 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 year, Ariadne Australia actually produced more free cash flow than EBIT. 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 Ariadne Australia has AU$12.9m in net cash. The cherry on top was that in converted 230% of that EBIT to free cash flow, bringing in AU$2.6m. So we don't have any problem with Ariadne Australia's use of debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Ariadne Australia has 2 warning signs (and 1 which is a bit concerning) we think 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.

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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