Does Verbrec (ASX:VBC) Have A Healthy Balance Sheet?

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' 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. As with many other companies Verbrec Limited (ASX:VBC) makes use of debt. 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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

See our latest analysis for Verbrec

How Much Debt Does Verbrec Carry?

The image below, which you can click on for greater detail, shows that at December 2020 Verbrec had debt of AU$3.59m, up from AU$3.00m in one year. However, it does have AU$11.1m in cash offsetting this, leading to net cash of AU$7.54m.

How Strong Is Verbrec's Balance Sheet?

We can see from the most recent balance sheet that Verbrec had liabilities of AU$23.1m falling due within a year, and liabilities of AU$3.76m due beyond that. Offsetting these obligations, it had cash of AU$11.1m as well as receivables valued at AU$19.5m due within 12 months. So it can boast AU$3.84m more liquid assets than total liabilities.

This short term liquidity is a sign that Verbrec could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Verbrec boasts net cash, so it's fair to say it does not have a heavy debt load!

Another good sign is that Verbrec has been able to increase its EBIT by 29% in twelve months, making it easier to pay down debt. When analysing debt levels, the balance sheet is the obvious place to start. But it is Verbrec's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. Verbrec 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. Happily for any shareholders, Verbrec actually produced more free cash flow than EBIT over the last three years. That sort of strong cash generation warms our hearts like a puppy in a bumblebee suit.

Summing up

While it is always sensible to investigate a company's debt, in this case Verbrec has AU$7.54m in net cash and a decent-looking balance sheet. The cherry on top was that in converted 170% of that EBIT to free cash flow, bringing in AU$7.2m. So is Verbrec's debt a risk? It doesn't seem so to us. 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. For example, we've discovered 2 warning signs for Verbrec that you should be aware of before investing here.

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. 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.
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