Does Alfabs Australia (ASX:AAL) Have A Healthy Balance Sheet?

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.' 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. As with many other companies Alfabs Australia Limited (ASX:AAL) makes use of debt. But is this debt a concern to shareholders?

When Is Debt Dangerous?

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. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. 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.

View our latest analysis for Alfabs Australia

What Is Alfabs Australia's Debt?

The image below, which you can click on for greater detail, shows that at June 2024 Alfabs Australia had debt of AU$19.4m, up from AU$14.5m in one year. But on the other hand it also has AU$23.6m in cash, leading to a AU$4.22m net cash position.

How Strong Is Alfabs Australia's Balance Sheet?

We can see from the most recent balance sheet that Alfabs Australia had liabilities of AU$42.0m falling due within a year, and liabilities of AU$17.0m due beyond that. Offsetting this, it had AU$23.6m in cash and AU$14.3m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by AU$21.1m.

Given Alfabs Australia has a market capitalization of AU$111.8m, it's hard to believe these liabilities pose much threat. Having said that, it's clear that we should continue to monitor its balance sheet, lest it change for the worse. While it does have liabilities worth noting, Alfabs Australia also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Alfabs Australia grew its EBIT by 48% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Alfabs Australia will need earnings to service that debt. 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.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. While Alfabs Australia 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. Over the last two years, Alfabs Australia recorded negative free cash flow, in total. Debt is usually more expensive, and almost always more risky in the hands of a company with negative free cash flow. Shareholders ought to hope for an improvement.

Summing Up

Although Alfabs Australia's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of AU$4.22m. And it impressed us with its EBIT growth of 48% over the last year. So we are not troubled with Alfabs Australia's debt use. 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. Case in point: We've spotted 3 warning signs for Alfabs Australia you should be aware of.

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.

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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.