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David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 Venture Life Group plc (LON:VLG) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt A Problem?
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. If things get really bad, the lenders can take control of the business. 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. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Venture Life Group Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Venture Life Group had debt of UK£6.62m, up from UK£4.37m in one year. But it also has UK£42.1m in cash to offset that, meaning it has UK£35.5m net cash.
A Look At Venture Life Group's Liabilities
According to the last reported balance sheet, Venture Life Group had liabilities of UK£10.00m due within 12 months, and liabilities of UK£10.6m due beyond 12 months. On the other hand, it had cash of UK£42.1m and UK£7.34m worth of receivables due within a year. So it actually has UK£28.9m more liquid assets than total liabilities.
This excess liquidity suggests that Venture Life Group is taking a careful approach to debt. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Venture Life Group has more cash than debt is arguably a good indication that it can manage its debt safely.
Better yet, Venture Life Group grew its EBIT by 203% last year, which is an impressive improvement. If maintained that growth will make the debt even more manageable in the years ahead. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Venture Life Group'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.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. Venture Life Group 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. In the last three years, Venture Life Group created free cash flow amounting to 16% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
While it is always sensible to investigate a company's debt, in this case Venture Life Group has UK£35.5m in net cash and a decent-looking balance sheet. And we liked the look of last year's 203% year-on-year EBIT growth. So we don't think Venture Life Group's use of debt is risky. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. For example Venture Life Group has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.
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.
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. 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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