Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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. We note that Surface Transforms Plc (LON:SCE) does have debt on its balance sheet. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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, 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 Surface Transforms Carry?
The chart below, which you can click on for greater detail, shows that Surface Transforms had UK£300.0k in debt in May 2019; about the same as the year before. But on the other hand it also has UK£1.93m in cash, leading to a UK£1.63m net cash position.
How Strong Is Surface Transforms's Balance Sheet?
We can see from the most recent balance sheet that Surface Transforms had liabilities of UK£672.0k falling due within a year, and liabilities of UK£470.0k due beyond that. On the other hand, it had cash of UK£1.93m and UK£895.0k worth of receivables due within a year. So it actually has UK£1.68m more liquid assets than total liabilities.
This surplus suggests that Surface Transforms has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Surface Transforms boasts net cash, so it's fair to say it does not have a heavy debt load! The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Surface Transforms's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Over 12 months, Surface Transforms made a loss at the EBIT level, and saw its revenue drop to UK£1.0m, which is a fall of 26%. That makes us nervous, to say the least.
So How Risky Is Surface Transforms?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Surface Transforms lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through UK£2.3m of cash and made a loss of UK£2.1m. Given it only has net cash of UK£1.63m, the company may need to raise more capital if it doesn't reach break-even soon. Overall, its balance sheet doesn't seem overly risky, at the moment, but we're always cautious until we see the positive free cash flow. For riskier companies like Surface Transforms 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.
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.
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