Is Carbon Revolution (ASX:CBR) A Risky Investment?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Carbon Revolution Limited (ASX:CBR) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Carbon Revolution

What Is Carbon Revolution's Debt?

The image below, which you can click on for greater detail, shows that Carbon Revolution had debt of AU$14.6m at the end of December 2021, a reduction from AU$16.5m over a year. But it also has AU$47.8m in cash to offset that, meaning it has AU$33.2m net cash.

How Healthy Is Carbon Revolution's Balance Sheet?

We can see from the most recent balance sheet that Carbon Revolution had liabilities of AU$26.7m falling due within a year, and liabilities of AU$16.9m due beyond that. On the other hand, it had cash of AU$47.8m and AU$12.6m worth of receivables due within a year. So it actually has AU$16.8m more liquid assets than total liabilities.

This surplus suggests that Carbon Revolution has a conservative balance sheet, and could probably eliminate its debt without much difficulty. Succinctly put, Carbon Revolution 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 Carbon Revolution'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.

In the last year Carbon Revolution had a loss before interest and tax, and actually shrunk its revenue by 2.2%, to AU$35m. We would much prefer see growth.

So How Risky Is Carbon Revolution?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Carbon Revolution had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of AU$54m and booked a AU$39m accounting loss. Given it only has net cash of AU$33.2m, the company may need to raise more capital if it doesn't reach break-even soon. Even though its balance sheet seems sufficiently liquid, debt always makes us a little nervous if a company doesn't produce free cash flow regularly. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Carbon Revolution is showing 5 warning signs in our investment analysis , you should know about...

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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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.