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.' 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 Clean Seed Capital Group Ltd. (CVE:CSX) does have debt on its balance sheet. But the more important question is: how much risk is that debt creating?
When Is Debt Dangerous?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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 examine debt levels, we first consider both cash and debt levels, together.
What Is Clean Seed Capital Group's Net Debt?
As you can see below, Clean Seed Capital Group had CA$2.38m of debt at June 2020, down from CA$3.62m a year prior. But on the other hand it also has CA$3.20m in cash, leading to a CA$817.5k net cash position.
How Healthy Is Clean Seed Capital Group's Balance Sheet?
According to the last reported balance sheet, Clean Seed Capital Group had liabilities of CA$2.16m due within 12 months, and liabilities of CA$1.43m due beyond 12 months. Offsetting this, it had CA$3.20m in cash and CA$24.5k in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by CA$362.4k.
Having regard to Clean Seed Capital Group's size, it seems that its liquid assets are well balanced with its total liabilities. So while it's hard to imagine that the CA$23.0m company is struggling for cash, we still think it's worth monitoring its balance sheet. While it does have liabilities worth noting, Clean Seed Capital Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Although Clean Seed Capital Group made a loss at the EBIT level, last year, it was also good to see that it generated CA$2.7m in EBIT over the last twelve months. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Clean Seed Capital Group can strengthen its balance sheet over time. 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. While Clean Seed Capital Group has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last year, Clean Seed Capital Group's free cash flow amounted to 49% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.
We could understand if investors are concerned about Clean Seed Capital Group's liabilities, but we can be reassured by the fact it has has net cash of CA$817.5k. So we are not troubled with Clean Seed Capital Group's debt use. 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. Consider for instance, the ever-present spectre of investment risk. We've identified 4 warning signs with Clean Seed Capital Group (at least 1 which is potentially serious) , and understanding them should be part of your investment process.
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.
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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