Is Electro Optic Systems Holdings (ASX:EOS) Using Debt In A Risky Way?

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. We can see that Electro Optic Systems Holdings Limited (ASX:EOS) does use debt in its business. But is this debt a concern to shareholders?

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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. 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. When we think about a company's use of debt, we first look at cash and debt together.

View our latest analysis for Electro Optic Systems Holdings

What Is Electro Optic Systems Holdings's Net Debt?

As you can see below, at the end of December 2021, Electro Optic Systems Holdings had AU$34.4m of debt, up from none a year ago. Click the image for more detail. But it also has AU$59.3m in cash to offset that, meaning it has AU$24.8m net cash.

How Strong Is Electro Optic Systems Holdings' Balance Sheet?

We can see from the most recent balance sheet that Electro Optic Systems Holdings had liabilities of AU$104.2m falling due within a year, and liabilities of AU$32.1m due beyond that. Offsetting these obligations, it had cash of AU$59.3m as well as receivables valued at AU$133.7m due within 12 months. So it actually has AU$56.6m more liquid assets than total liabilities.

This short term liquidity is a sign that Electro Optic Systems Holdings could probably pay off its debt with ease, as its balance sheet is far from stretched. Simply put, the fact that Electro Optic Systems Holdings has more cash than debt is arguably a good indication that it can manage its debt safely. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Electro Optic Systems Holdings can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Over 12 months, Electro Optic Systems Holdings reported revenue of AU$212m, which is a gain of 18%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.

So How Risky Is Electro Optic Systems Holdings?

Statistically speaking companies that lose money are riskier than those that make money. And in the last year Electro Optic Systems Holdings had an earnings before interest and tax (EBIT) loss, truth be told. Indeed, in that time it burnt through AU$28m of cash and made a loss of AU$16m. Given it only has net cash of AU$24.8m, 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. 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. Case in point: We've spotted 1 warning sign for Electro Optic Systems Holdings you should be aware of.

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.