Is Velocity Minerals (CVE:VLC) Using Too Much Debt?

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 Velocity Minerals Ltd. (CVE:VLC) does use debt in its business. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Velocity Minerals

What Is Velocity Minerals's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2019 Velocity Minerals had debt of CA$3.99m, up from none in one year. However, its balance sheet shows it holds CA$7.89m in cash, so it actually has CA$3.90m net cash.

How Healthy Is Velocity Minerals's Balance Sheet?

We can see from the most recent balance sheet that Velocity Minerals had liabilities of CA$562.9k falling due within a year, and liabilities of CA$3.99m due beyond that. Offsetting this, it had CA$7.89m in cash and CA$64.0k in receivables that were due within 12 months. So it can boast CA$3.40m more liquid assets than total liabilities.

This surplus suggests that Velocity Minerals has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Simply put, the fact that Velocity Minerals has more cash than debt is arguably a good indication that it can manage its debt safely. There's no doubt that we learn most about debt from the balance sheet. But it is Velocity Minerals's earnings that will influence how the balance sheet holds up in the future. 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.

Since Velocity Minerals has no significant operating revenue, shareholders probably hope it will develop a valuable new mine before too long.

So How Risky Is Velocity Minerals?

Statistically speaking companies that lose money are riskier than those that make money. And we do note that Velocity Minerals had negative earnings before interest and tax (EBIT), over the last year. And over the same period it saw negative free cash outflow of CA$3.1m and booked a CA$3.4m accounting loss. However, it has net cash of CA$7.9m, so it has a bit of time before it will need more capital. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. For riskier companies like Velocity Minerals I always like to keep an eye on whether insiders are buying or selling. So click here if you want to find out for yourself.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.