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.' 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 note that Naturhouse Health, S.A. (BME:NTH) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

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 usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first step when considering a company's debt levels is to consider its cash and debt together.

Check out our latest analysis for Naturhouse Health

What Is Naturhouse Health's Debt?

You can click the graphic below for the historical numbers, but it shows that Naturhouse Health had €2.75m of debt in June 2019, down from €3.04m, one year before. But on the other hand it also has €18.9m in cash, leading to a €16.1m net cash position.

How Strong Is Naturhouse Health's Balance Sheet?

According to the last reported balance sheet, Naturhouse Health had liabilities of €18.6m due within 12 months, and liabilities of €12.6m due beyond 12 months. Offsetting these obligations, it had cash of €18.9m as well as receivables valued at €7.72m due within 12 months. So its liabilities total €4.59m more than the combination of its cash and short-term receivables.

Of course, Naturhouse Health has a market capitalization of €116.9m, so these liabilities are probably manageable. However, we do think it is worth keeping an eye on its balance sheet strength, as it may change over time. While it does have liabilities worth noting, Naturhouse Health also has more cash than debt, so we're pretty confident it can manage its debt safely.

In fact Naturhouse Health's saving grace is its low debt levels, because its EBIT has tanked 25% 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 Naturhouse Health'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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. While Naturhouse Health 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. Over the most recent three years, Naturhouse Health recorded free cash flow worth 67% of its EBIT, which is around normal, given free cash flow excludes interest and tax. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Summing up

While it is always sensible to look at a company's total liabilities, it is very reassuring that Naturhouse Health has €16m in net cash. The cherry on top was that in converted 67% of that EBIT to free cash flow, bringing in €17m. So we are not troubled with Naturhouse Health's debt use. We'd be motivated to research the stock further if we found out that Naturhouse Health 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, 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.