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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 can see that Beacon Lighting Group Limited (ASX:BLX) does use debt in its business. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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 Beacon Lighting Group Carry?
The image below, which you can click on for greater detail, shows that Beacon Lighting Group had debt of AU$20.9m at the end of December 2021, a reduction from AU$21.8m over a year. However, it does have AU$34.2m in cash offsetting this, leading to net cash of AU$13.3m.
A Look At Beacon Lighting Group's Liabilities
According to the last reported balance sheet, Beacon Lighting Group had liabilities of AU$91.9m due within 12 months, and liabilities of AU$102.4m due beyond 12 months. Offsetting these obligations, it had cash of AU$34.2m as well as receivables valued at AU$8.32m due within 12 months. So its liabilities total AU$151.8m more than the combination of its cash and short-term receivables.
This deficit isn't so bad because Beacon Lighting Group is worth AU$469.0m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Beacon Lighting Group also has more cash than debt, so we're pretty confident it can manage its debt safely.
Also good is that Beacon Lighting Group grew its EBIT at 17% over the last year, further increasing its ability to manage debt. 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 Beacon Lighting 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. Beacon Lighting 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. During the last three years, Beacon Lighting Group generated free cash flow amounting to a very robust 83% of its EBIT, more than we'd expect. That puts it in a very strong position to pay down debt.
While Beacon Lighting Group does have more liabilities than liquid assets, it also has net cash of AU$13.3m. The cherry on top was that in converted 83% of that EBIT to free cash flow, bringing in AU$43m. So we don't think Beacon Lighting Group's use of debt is risky. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 2 warning signs we've spotted with Beacon Lighting Group .
If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.
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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.