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.' 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 Major Drilling Group International Inc. (TSE:MDI) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Major Drilling Group International

How Much Debt Does Major Drilling Group International Carry?

As you can see below, Major Drilling Group International had CA$15.7m of debt at January 2021, down from CA$16.6m a year prior. But it also has CA$30.0m in cash to offset that, meaning it has CA$14.2m net cash.

How Healthy Is Major Drilling Group International's Balance Sheet?

According to the last reported balance sheet, Major Drilling Group International had liabilities of CA$59.8m due within 12 months, and liabilities of CA$32.0m due beyond 12 months. Offsetting this, it had CA$30.0m in cash and CA$83.9m in receivables that were due within 12 months. So it actually has CA$22.1m more liquid assets than total liabilities.

This short term liquidity is a sign that Major Drilling Group International could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Major Drilling Group International has more cash than debt is arguably a good indication that it can manage its debt safely.

In fact Major Drilling Group International's saving grace is its low debt levels, because its EBIT has tanked 27% in the last twelve months. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Major Drilling Group International's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. While Major Drilling Group International 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. Looking at the most recent two years, Major Drilling Group International recorded free cash flow of 45% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Major Drilling Group International has CA$14.2m in net cash and a decent-looking balance sheet. So we don't have any problem with Major Drilling Group International's use of debt. We'd be motivated to research the stock further if we found out that Major Drilling Group International insiders have bought shares recently. If you would too, then you're in luck, since today we're sharing our list of reported insider transactions for free.

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. 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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