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 might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that TeraGo Inc. (TSE:TGO) does use debt in its business. But the more important question is: how much risk is that debt creating?

Why Does Debt Bring Risk?

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. 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. 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. When we think about a company's use of debt, we first look at cash and debt together.

See our latest analysis for TeraGo

What Is TeraGo's Debt?

The image below, which you can click on for greater detail, shows that TeraGo had debt of CA$31.8m at the end of March 2019, a reduction from CA$35.3m over a year. On the flip side, it has CA$3.11m in cash leading to net debt of about CA$28.7m.

How Healthy Is TeraGo's Balance Sheet?

According to the last reported balance sheet, TeraGo had liabilities of CA$15.5m due within 12 months, and liabilities of CA$52.0m due beyond 12 months. On the other hand, it had cash of CA$3.11m and CA$3.12m worth of receivables due within a year. So its liabilities total CA$61.3m more than the combination of its cash and short-term receivables.

TeraGo has a market capitalization of CA$170.3m, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine TeraGo's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, TeraGo saw its revenue drop to CA$53m, which is a fall of 3.5%. We would much prefer see growth.

Caveat Emptor

Over the last twelve months TeraGo produced an earnings before interest and tax (EBIT) loss. To be specific the EBIT loss came in at CA$403k. When we look at that and recall the liabilities on its balance sheet, relative to cash, it seems unwise to us for the company to have any debt. So we think its balance sheet is a little strained, though not beyond repair. For example, we would not want to see a repeat of last year's loss of-CA$4.7m. So to be blunt we do think it is risky. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how TeraGo's profit, revenue, and operating cashflow have changed over the last few years.

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.

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.