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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.' 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. As with many other companies Eden Innovations Ltd (ASX:EDE) makes use of debt. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.
How Much Debt Does Eden Innovations Carry?
As you can see below, at the end of December 2020, Eden Innovations had AU$5.10m of debt, up from AU$836.4k a year ago. Click the image for more detail. But it also has AU$5.54m in cash to offset that, meaning it has AU$446.5k net cash.
How Strong Is Eden Innovations' Balance Sheet?
According to the last reported balance sheet, Eden Innovations had liabilities of AU$5.52m due within 12 months, and liabilities of AU$532.6k due beyond 12 months. On the other hand, it had cash of AU$5.54m and AU$324.8k worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$188.6k.
This state of affairs indicates that Eden Innovations' balance sheet looks quite solid, as its total liabilities are just about equal to its liquid assets. So it's very unlikely that the AU$72.7m company is short on cash, but still worth keeping an eye on the balance sheet. Despite its noteworthy liabilities, Eden Innovations boasts net cash, so it's fair to say it does not have a heavy debt load! There's no doubt that we learn most about debt from the balance sheet. But it is Eden Innovations'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.
Over 12 months, Eden Innovations reported revenue of AU$2.8m, which is a gain of 36%, although it did not report any earnings before interest and tax. With any luck the company will be able to grow its way to profitability.
So How Risky Is Eden Innovations?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Eden Innovations had an earnings before interest and tax (EBIT) loss, over the last year. And over the same period it saw negative free cash outflow of AU$8.6m and booked a AU$7.9m accounting loss. With only AU$446.5k on the balance sheet, it would appear that its going to need to raise capital again soon. Eden Innovations's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 6 warning signs for Eden Innovations (2 make us uncomfortable!) that you should be aware of before investing here.
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. 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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