Does Babylon Pump & Power (ASX:BPP) Have A Healthy Balance Sheet?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that Babylon Pump & Power Limited (ASX:BPP) does use debt in its business. But the more important question is: how much risk is that debt creating?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own 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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Babylon Pump & Power

How Much Debt Does Babylon Pump & Power Carry?

You can click the graphic below for the historical numbers, but it shows that Babylon Pump & Power had AU$11.7m of debt in June 2023, down from AU$15.6m, one year before. However, because it has a cash reserve of AU$1.56m, its net debt is less, at about AU$10.2m.

A Look At Babylon Pump & Power's Liabilities

The latest balance sheet data shows that Babylon Pump & Power had liabilities of AU$19.5m due within a year, and liabilities of AU$6.21m falling due after that. On the other hand, it had cash of AU$1.56m and AU$5.76m worth of receivables due within a year. So its liabilities total AU$18.4m more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the AU$9.88m company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Babylon Pump & Power would likely require a major re-capitalisation if it had to pay its creditors today. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Babylon Pump & Power 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.

Over 12 months, Babylon Pump & Power reported revenue of AU$34m, which is a gain of 22%, although it did not report any earnings before interest and tax. Shareholders probably have their fingers crossed that it can grow its way to profits.

Caveat Emptor

Despite the top line growth, Babylon Pump & Power still had an earnings before interest and tax (EBIT) loss over the last year. Indeed, it lost AU$96k at the EBIT level. When we look at that alongside the significant liabilities, we're not particularly confident about the company. We'd want to see some strong near-term improvements before getting too interested in the stock. Not least because it had negative free cash flow of AU$56k over the last twelve months. So suffice it to say we consider the stock to be risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 2 warning signs for Babylon Pump & Power you should be aware of.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.