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Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. Importantly, Cake Box Holdings Plc (LON:CBOX) does carry debt. But the real question is whether this debt is making the company risky.
When Is Debt Dangerous?
Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Cake Box Holdings Carry?
The image below, which you can click on for greater detail, shows that Cake Box Holdings had debt of UK£1.49m at the end of March 2021, a reduction from UK£1.61m over a year. But it also has UK£5.51m in cash to offset that, meaning it has UK£4.02m net cash.
How Healthy Is Cake Box Holdings' Balance Sheet?
The latest balance sheet data shows that Cake Box Holdings had liabilities of UK£4.91m due within a year, and liabilities of UK£1.85m falling due after that. Offsetting these obligations, it had cash of UK£5.51m as well as receivables valued at UK£2.06m due within 12 months. So it can boast UK£805.0k more liquid assets than total liabilities.
This state of affairs indicates that Cake Box Holdings' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So while it's hard to imagine that the UK£138.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. Simply put, the fact that Cake Box Holdings has more cash than debt is arguably a good indication that it can manage its debt safely.
Another good sign is that Cake Box Holdings has been able to increase its EBIT by 25% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Cake Box Holdings'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.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Cake Box Holdings 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. During the last three years, Cake Box Holdings produced sturdy free cash flow equating to 61% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.
While it is always sensible to investigate a company's debt, in this case Cake Box Holdings has UK£4.02m in net cash and a decent-looking balance sheet. And we liked the look of last year's 25% year-on-year EBIT growth. So is Cake Box Holdings's debt a risk? It doesn't seem so to us. 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. For instance, we've identified 2 warning signs for Cake Box Holdings that you should be aware of.
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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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