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, Saga Communications, Inc. (NASDAQ:SGA) does carry debt. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Saga Communications

What Is Saga Communications's Net Debt?

As you can see below, Saga Communications had US$10.0m of debt, at March 2021, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$56.3m in cash, so it actually has US$46.3m net cash.

How Healthy Is Saga Communications' Balance Sheet?

According to the last reported balance sheet, Saga Communications had liabilities of US$13.9m due within 12 months, and liabilities of US$41.7m due beyond 12 months. On the other hand, it had cash of US$56.3m and US$13.8m worth of receivables due within a year. So it can boast US$14.6m more liquid assets than total liabilities.

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

It is just as well that Saga Communications's load is not too heavy, because its EBIT was down 85% over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. When analysing debt levels, the balance sheet is the obvious place to start. But it is Saga Communications's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Saga Communications 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. Happily for any shareholders, Saga Communications actually produced more free cash flow than EBIT over the last three years. That sort of strong cash conversion gets us as excited as the crowd when the beat drops at a Daft Punk concert.

Summing up

While it is always sensible to investigate a company's debt, in this case Saga Communications has US$46.3m in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of US$10m, being 102% of its EBIT. So we are not troubled with Saga Communications's debt use. 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. We've identified 2 warning signs with Saga Communications (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

Of course, if you're the type of investor who prefers buying stocks without the burden of debt, then don't hesitate to discover our exclusive list of net cash growth stocks, today.

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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